Review Questions 101.docx

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