Review Questions 101.docx
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ReviewQuestions101
FIN2108ReviewQuestions10.1
Reviewquestions10.1
10.1.1Pleaseattemptquestions1-7ofSathyeetal.chapter10
10.1.2WritenotesontheEurocurrencyMarket,theEurobondMarketandEurocredits.
10.1.3WhatisLIBOR?
10.1.4Definetransactionexposure,translationexposureandeconomicexposure.
10.1.5Throughtheuseofexamples,explainthedifferencebetweencreditriskandsovereignrisk.
10.1.6Outlinesomeofthemeasuresusedincountryriskanalysis.
10.1.7Writenotesondocumentarycollections,bankers’acceptanceanddocumentarylettersofcredit
10.1.8Comparepre-payment,documentarycollections(drafts),lettersofcreditandopenaccountfinancingoptionsintermsoftherisksinvolvedforexportersandimporters.
Chapter10:
InternationalLending
ReviewQuestions10.1.1Solutionstodiscussionquestions
Q1.AcompanysellsgoodstoMeghanEnterpriseson‘openaccount’terms.Explainthemethodsbywhichtheimporterscanpayandcomparethemfromtheexporter’sviewpoint.
‘Openaccount’iswheretheexporterdispatchesthegoodstotheimporteronaninvoicebasisoraccount.Thisissimilartotradetermsusedlocallybymanysuppliers.Heretheexporterneedstotrustthattheimporterwillpayandhavetheresourcestodoso.
Theimporterobtainstitletothegoodswithoutpaymentandcanpotentiallysellthegoodsbeforepayment;thisdependsonthetermsofsettlementagreedbetweenimporterandexporter
Itsmainadvantagesaresimplicityandlowcosts.Theclienthasnoriskofpayingandnotreceivingthegoods.Thebuyersimilarlycanusetheirfundsforotherpurposesuntilthegoodsareactuallyreceived.Theinvoicecansimilarlybestructuredtoofferthebuyertradecredit(payin30to90daysfrominvoicedate)terms.
Theaccountorinvoicecanbepaidbytelegraphictransferordraftorbycreditingtheexportersaccountdirectlyoverseas.
Thisformoftradetermisusuallyreservedforeitherverygoodclientsorsubsidiariesofoverseascorporations.Thisisbecausethereisasignificantlevelofdefaultrisk.Theimportermayreceivethegoodsandnotpayforthem.
Itisofcourseoftenrequestedbytheimporter,andinacompetitivemarkettheremaybesomepressureontheexportertotradeonopenaccountterms.Inthiscasetheuseofsomeformofexportcreditinsurancewillmitigatetherisktosomedegree.
Q2.Whatiscountryriskanalysis?
∙Countryriskanalysisistheevaluationoftheworthofthecountryandtheabilitytodealwiththecountryasanentity.
∙Thiscanoccurbecausethereisawishtodealwiththecountryitselforbeforeanalysisoftheindividualcorporatecancommence.
∙Thereasonforcountryanalysisfirstisthatthecorporatemaybeanexceptionaldealbuttherisksofdealingwiththecountryoutweightheopportunity.
Informationcanbegainedfrommanysources:
a.Reputationandefficiencyoflocalorganisations.
b.Operationofthecentralbankanditsapplicationofmonetarypolicy.
c.Governmentagenciesandtheirdegreeofhelpandcooperation.
d.Embassiesandrepresentativeoffices.
e.Magazinesandnewspapers.
f.Informationfromratingagencies.
Inanylendingpropositionthatinvolvesthirdcountryriskthetopdownapproach(seeQuestion3)mustbeadheredtoandintheorderasgiven.
Q3.Asuggestedmethodofcreditevaluationisthestep-downapproach,ortheevaluationofinstitutionsinacountryindescendingorderofimportance.Whatarethemajorpointstobeconsideredinthismethod?
1.Countryanalysis–
1.geography
2.Demographics
3.currency
4.ensureacceptabilityandfit.
2.Governmentsectoranalysis–
1.isthestyleandtypeofgovernmentacceptabletoourown?
2.arethereanytradebarriersinplaceoranyproblemswithpaymentpotential
3.whatisthegovernment’screditstanding?
4.Howstableisthegovernment?
3.Centralbankanalysis–
1.whatisthelevelofindependence?
2.howdoesitapplymonetarypolicy?
4.Commercialbanksectoranalysis–
1.viabilityandprofessionalismofthesector
2.dothebankshonourtheircommitments?
5.Corporatesectoranalysis–
1.howstrongisthesector?
2.whatarethereputationalissues?
3.Etc.
Q4.Whataretheprinciplesofinternationallending?
A.Safety
Security
Suitability
Profitability
Bearinmindthatanunderstandingoftheoverseasmarketisessential.Itisafactthatinternationalactivitiesareinherentlymoreriskyandpotentiallymoreexpensivethanlocaloperations.
Q5.Explainthedifferencesbetweenthefollowinginstruments:
(a)Irrevocableletterofcredit–cannotbewithdrawnorcancelledunlessagreedtobyallpartiesassociatedwiththeestablishmentofthecredit.
(b)Back-to-backcredit–oneletterofcreditisusedasmake-weightsecurityfortheestablishmentofanotherletterofcreditforthefinalsettlementofthegoodsorservices.
(c)Redclausecredit–oldfashionedtermbasedontermswrittenontheoriginalletterofcreditinredink.AredclausecreditisaclausewithinanLCthatauthorisestheexporter’sbanktomakeanimmediatepaymenttotheexporter,i.e.itfacilitatespre-shipmentfinance.Itenablestheexportertoobtainanoverdraftfromtheadvisingbank.Thefacilityisgenerallyrestrictedtoexporterswhoseintegrityisconsideredunquestionablebytheoverseasbuyer,ortoaffiliateorsubsidiaryfirms.
(d)Openaccount-Openaccountiswheretheexporterdespatchesthegoodstotheimporteronaninvoicebasisoraccount.
Q6.Howcantheriskofinternationalproblemloansbereduced?
A.
∙Verystrongcreditanalysis
∙Useofmanysourcesofinformation
∙Accessibilitytoratingagencies
∙Stepdownanalysis
∙Experiencedstaff
∙Rulesandguidelines
∙Abilitytoreactquicklytochangingcircumstances
∙Crystallisationofguidelines
Alsonotethepointadditionalpointscontainedinsection10.2
ThirdPartyHelp:
Foreigngovernmentsandcentralbanksareoftenwillingtoprovideguaranteesforloans.Inaddition,creditderivativescanenableabanktosellthecreditriskinherentinaloan.BankslendingtoexportersmayalsotargetonlythosethatinsuretheirtradecreditthroughaninstitutionsuchastheForeignCreditInsuranceAssociationintheUS.
Poolingrisk:
Bankscanreducerisksviasyndicationarrangements(alsocalledparticipationloans).Banksjointogethertoprovidefundsforloans.Largebankstypicallymaketheirownassessmentofcreditandpolitical/sovereignrisks.Smallerbanksmayrelyonthereportspreparedbythelargebanks.
Diversification(acrossindustries,regions,countriesetc):
Theextenttowhichdiversificationcanreducetheriskinaportfoliorelatestohowthereturnsofthevariousloansarecorrelated.Wherethecorrelationislower,thebenefitsofdiversificationareincreased.
Newinnovationstoreducecountryrisk:
TheInternationalFinanceCorporation(IFC),aunitoftheWorldBank,constructsparticipationloanstoprivateborrowersindevelopingcountriesthatallowbankstoextendloanswithoutbearingthecountryriskassociatedwiththeloan.Thelenderstillbearscreditriskhowever.TheIFCtypicallyholds25%ofthedebtandsellstheremaining75%toparticipatingbanks.LoansaretypicallyforamountsbetweenUS$5millionandUS$100million.Yieldsrangefrom2%to3.5%aboveLIBORtypically.
Q7.Whatarethebenefitstoafinancialinstitutionofinvolvementwithclientsusingbankguarantees?
Abankguaranteeiswhereafinancialinstitutionsuperimposesitscreditstandingforthatoftheclient.Thereforethebenefittoanotherfinancialinstitutionindealingwithaclientwhosuppliesabankguaranteeisthatthecreditworthinessofthesupplyingbankismostrelevantintermsofdefaultrisk,ratherthanthecreditworthinessofthecustomer.
ReviewQuestion10.1.2-10.1.8
10.1.2WritenotesontheEurocurrencyMarket,theEurobondMarketandEurocredits.
EurocurrencyMarket
∙Eurocurrencyisaliabilitydenominatedinaforeigncurrency.
∙ActiveEuromarketsexistinEuropeandAsia,includingSingapore,HongKongandTokyoForexample,anAustralianbankreceivesadepositdenominatedinUSD.Theacceptingbankmustbelocatedoutsidethecountrythatissuesthecurrency.
∙TheEurodollardepositsarethedominantEurocurrency.TheseareUSdollarliabilitiesofabanklocatedoutsideoftheUnitedStates.EurodollardepositsareequivalenttoUSCDs.
∙Theyarelargedenominations(multiplemillions),havefixedmaturities,andpayratesslightlyabovethecomparableCDsissuesbyUSbanks.
∙Theymaybenegotiableornon-negotiable.
∙ThereisanactivesecondarymarketinnegotiableEurocurrencyCDs,sobankscanliquidatetheirholdingspriortomaturity
∙ThereareotherEurocurrenciesapartfromtheUSDsuchasEurosterling.
∙Therearealso‘atcall’deposits,generallymadebybankswantingtoearninterestonshorttermliquiditysurpluses.However,somedepositorsleavethefundsforlongperiods,andhencetheycanbeasourceofcheapfundingforbanks
EurobondMarket
∙Eurobondsaredebtinstrumentsdenominatedinaforeigncurrency
∙ThemainissuersofEurobondsarenon-financialcorporations.
∙Internationalbankswithinvestmentsubsidiariesunderwritethebondissues.
∙Banksalsoissuebondsandsomeissuefloatingratenotes,typicallyatafixedspreadover6monthLIBOR.
∙Theissuingbankobtainslong-termfinancingbutpaysshort-termrates.
∙Eurobondscanbeissuedinanycurrencyoranartificialcurrency,suchastheSpecialDrawingRight,Eurco,theEuropeanUnitofAccountortheEuropeanCurrencyUnit.
∙Theyaresubjecttolimitedregulationbecausetheyareunderwrittenbyaninternationalbankingsyndic