II MIB GFM

8/13/2019 II MIB GFM

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COURSE : II.MIB

SEMESTER : IV

SUBJECT : GLOBAL FINANCIAL MANAGEMENT

FACULTY : L.PRAKASH

Unit I

Meaning and Definition of Money Market

Financial Market that facilitates the flow of short-term funds ( with maturities are

less than one year )are known as Money market.There are two types of financial markets

viz., the money market and the capital market. The money market in that part of a financial

market which deals in the borrowin and lendin of short term loans enerally for a period

of less than or e!ual to "#$ days. %t is a mechanism to clear short term monetary

transactions in an economy.

&ccordin to 'rowther, The money market is a name iven to the various firms and

institutions that deal in the various rades of near money.

&ccordin to adler and *hipman, & money market is a mechanical device throuh

which short term funds are loaned and borrowed throuh which a lare part of the financial

transactions of a particular country or world are deraded. & money market is distinct from

but supplementary to the commercial bankin system.

These definitions help us to identify the basic characteristics of a money market. &

money market comprises of a well oranized bankin system. +arious financial instruments

are used for transactions in a money market. There is perfect mobility of funds in a money

market. The transactions in a money market are of short term nature.

Functions of Money Market

Money market is an important part of the economy. %t plays very sinificant

functions. &s mentioned above it is basically a market for short term monetary transactions.

Thus it has to provide facility for adustin li!uidity to the banks, business corporations,

non-bankin financial institutions (Fs) and other financial institutions alon with

investors.Maor Functions are iven below

To maintain monetary e!uilibrium. %t means to keep a balance between the demand

for and supply of money for short term monetary transactions.

To promote economic rowth. Money market can do this by makin funds available

to various units in the economy such as ariculture, small scale industries, etc.

To provide help to Trade and %ndustry. Money market provides ade!uate finance to

trade and industry. *imilarly it also provides facility of discountin bills of e/chane for

trade and industry.


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To help in implementin Monetary 0olicy. %t provides a mechanism for an effective

implementation of the monetary policy.

To help in 'apital Formation. Money market makes available investment avenues for

short term period. %t helps in eneratin savins and investments in the economy.

Money market provides non-inflationary sources of finance to overnment. %t ispossible by issuin treasury bills in order to raise short loans. 1owever this dose not leads

to increases in the prices.

Definition of International Money market

& division of the 'hicao Mercantile 2/chane ('M2) that deals with the tradin of

currency and interest rate futures and options. Tradin on the %MM started in May 3456

when the 'M2 and the %MM mered.

Money Market Instruments

The Maor purposes of financial Market is to transferfunds from 7enders to

orrowers.The %nstruments are as follows..

%.Treasury bills

Treasury bills are short-term securitiesissued by the 8.*. Treasury. The Treasury

sells bills at reularly scheduled auctions to refinance ma2ale Traders issues. %t alsohelps to finance current federal deficits. They further sell bills on an irreular basis to

smooth out the uneven flow of revenues from corporate and individual ta/ receipts.

%%.'ertificates of deposit

& certificate of depositis a document evidencin a time deposit placed with a depository

institution.

The followin information appears on the certificate9

- the amount of the deposit:- the date on which it matures:

- the interest rate: and- the method under which the interest is calculated.

7are neotiable ';s are enerally issued in denominations of


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There are basically two types of instruments issued and traded in the money market,

namely9

%nstruments which pay interest on the amount invested, where the interest is normally paid

to the holder of the instrument (the lender), toether with the redemption amount at

redemption date. %nterim interest payments may be made in certain cases. These

instruments are called interest instruments. %nstruments in this cateory include9

eotiable certificates of deposit (';s)

*hort-term overnment stock

%nterest rate instruments issued by the private sector, with terms to maturity of less than

three years.

%nstruments that do not pay interest on the amount invested but are issued at a discount on

the nominal value (the redemption amount). These instruments are called discount

instruments. %nstruments in this cateory include9

ankers= acceptances (&s)

Treasury bills (Ts)

'ommercial paper

7and ank bills

eotiable certificates of deposit (';s)

& neotiable certificate of deposit is a certificate issued by a bank for a deposit made at the

bank. This deposit attracts a fi/ed rate of interest, which is normally payable to the holder

of the instrument toether with the nominal amount invested, at redemption date. ';s

are normally issued in multiples of >3 million. The '; will contain the followin

information9

name of the issuin bank

date of issue

date of redemption (maturity date)

amount of the deposit

maturity value

annual interest rate paid on the deposit.

';s are bearer documents which means that the name of the owner (holder or depositor)does not appear on the document. The bearer or holder of the document will receive the

maturity value (the amount deposited plus interest) at maturity date.

?overnment stock and other short-term interest rate instruments


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?overnment stock and other private sector instruments are normally issued for lon-term

periods with more than one interest payment before redemption. The e/planation and

calculation of these instruments will be done in the section on the capital market

@here the term to redemption of a overnment stock or other interest rate instrument has

moved into the money market cateory, and there is ust one interest payment left, which

falls on the same date as the redemption payment, the same calculations as for the ';

ankers= acceptances

& bankers= acceptance was invented to suit the needs of a party re!uirin temporary finance

to facilitate the tradin of specific oods. The party needin finance would approach

investors for this temporary finance. The investors or lenders would then lend a certain

amount to the borrower in e/chane for a document statin that the debt would be paid

back on a certain date in the short-term future. For this arranement to be attractive to

the lender, the amount paid back by the borrower (called the nominal amount) would have

to be more than the amount advanced by die lender. The difference between the amount

advanced and the amount paid back (the nominal amount) is known as the discount on thenominal amount. The two parties would normally be brouht toether by a bank.

The redemption of the loan would have to be uaranteed by a bank, called the acceptance

by the bank makin the arranement. Thus the name bankers= acceptance.

The holder of the document may, at the redemption date approach the bank who will pay

the nominal amount to the holder. The bank will then claim the nominal amount from the

borrower.

& bank acceptance can, in formal terms, be described as an unconditional order in writin

addressed and sined by a drawer (the lender)

to a bank which sins the document and becomes the acceptor

promisin to pay a certain amount of money at a fi/ed date in the future

to the bearer or holder (the borrower) of the document (the acceptance).

Treasury bills

The overnment issues treasury bills They are discount instruments issued for the

short term, similar to &s. The issue and redemption of these instruments are handled by

die >eserve ank on behalf of the overnment. Treasury bills are issued in bearer form,

and the bearer or holder of the instrument may present it for payment of the nominal

amount at redemption date. The >eserve ank would normally pay this amount into the

holder=s current bank account on the redemption date.

@eekly treasury bills are issued and allocated on a tender basis. These bills have a

tenor of 43 days and are allocated to interested parties who submitted tenders on

these bills on a Friday for settlement durin the followin week. The amount of bills

on offer for that week is announced in multiples of >3 million the previous Thursday.


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'ommercial paper and other discount instruments

'ommercial paper refers to short-term unsecured promissory notes normally issued

by corporatecompanies with a hih credit ratin. These instruments are also issued

on a discount basis such as &s. ecause they are unsecured, the risk involved will

be hiher than that of &s, and therefore the issuin institution must be financially

stron and sound. ecause of the risk attached to these instruments they would

normally be issued and traded at a hiher discount than the prevailin & rate.

Treasury Bills:

Treasury ills are Money Market instruments to finance the short term re!uirements of the

?overnment of %ndia. These are discounted securities and thus are issued at a discount to

face value. The return to the investor is the difference between the maturity value and issue

price

Treasury ills or T-ills as they are known are issued by the ?overnment of %ndia to meet

their short-term re!uirement. T-ills are issued for 43-day, 3A6-day and "#B-day

maturities. T-ills are issued at a discount to their face value and redeemed at par.

"#B-day T-ills forms part of the overnment borrowin proramme.There are three types

of Treasury ills.

91-day T-bill - maturity is in 43 days. %ts auction is weekly on every @ednesday.

1!-day T-bill - maturity is in 3A6 days. %ts auction is on every alternate @ednesday other

than a reportin week.

"#$-Day T-bill - maturity is in "#B days. %ts auction is on every alternate @ednesday in a

reportin week.

Features of T-Bills auction

&ll T-ills auctions are 0rice-based.

&ll T-ills are auctioned on Multiple-0rice basis.

The >% auctions 43-day T-ills every @ednesday, 3A6-day T-ills on every alternate

wednesday and "#B-day T-ills on the @ednesday of the reportin Friday week.

'ommercial 0apers9

'ommercial 0aper is a low-cost alternative to bank loans. %t is a short term unsecuredpromissory note issued by corporates and financial institutions at a discounted value on face

value. They are usually issued with fi/ed maturity between one to 65C days and for

financin of accounts receivables, inventories and meetin short term liabilities. *ay, for

e/ample, a company has receivables of >s 3 lacs with credit period of # months. %t will not

be able to li!uidate its receivables before # months. The company is in need of funds. %t can

issue commercial papers in form of unsecured promissory notes at discount of 3CD on face

value of >s 3 lacs to be matured after # months. The company has stron credit ratin and


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finds buyers easily. The company is able to li!uidate its receivables immediately and the

buyer is able to earn interest of >s 3CE over a period of # months. They yield hiher returns

as compared to T-ills as they are less secure in comparison to these bills. 'hances of

default are almost neliible but are not zero risk instruments. 'ommercial 0aper bein an

instrument not backed by any collateral, only firms with hih !uality credit ratins will find

buyers easily without offerin any substantial discounts. They are issued by corporates toimpart fle/ibility in raisin workin capital resources at market determined rates.

'ommercial 0apers are actively traded in the secondary market since they are issued in the

form of promissory notes and are freely transferable in demat form.

%ertificate of De&osit:

%t is a short term borrowin more like a bank term deposit account. %t is a promissory note

issued by a bank in form of a certificate entitlin the bearer to receive interest. The

certificate bears the maturity date, the fi/ed rate of interest and the value. %t can be issued

in any denomination. They are stamped and transferred by endorsement. %ts term enerally

ranes from three months to five years and restricts the holders to withdraw funds on

demand. 1owever, on payment of certain penalty the money can be withdrawn on demand.

The returns on 'ertificate of ;eposits are hiher than T-ills because it assumes hiher

level of risk. @hile buyin 'ertificate of ;eposit, return method should be seen. >eturns can

be based on &nnual 0ercentae ield (&0) or &nnual 0ercentae >ate (&0>). %n &0,

interest earned is based on compounded interest calculation. 1owever, in &0> method,

simple interest calculation is done to enerate the return. &ccordinly, if the interest is paid

annually, e!ual return is enerated by both &0 and &0> methods.

1owever, if interest is paid more than once in a year, it is beneficial to opt &0 over &0>.

'd(antages of %ertificate of De&osit as a money market instrument:

*ince one can know the returns from before, the certificates of deposits are considered

much safe.

Gne can earn more as compared to depositin money in savins account.

;isadvantaes of 'ertificate of ;eposit as a Money Market instrument9

&s compared to other investments the returns is less.

The money is tied up alon with the lon maturity period of the 'ertificate of ;eposit. 1ue

penalties are paid if one ets out of it before maturity.

@hat are the Types of Money Market %nstruments in %ndia

Money market instruments rant for borrowers= short-term wants and ives needed

li!uidity to lenders. The types of money market instruments are treasury bills,

repurchase areements, commercial papers, certificate of deposit, and bankerHs

acceptance.
http://www.paisacontrol.com/stock-market-articles/what-are-the-types-of-money-market-instruments-in-indiahttp://www.paisacontrol.com/stock-market-articles/what-are-the-types-of-money-market-instruments-in-india


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I Treasury ills

Treasury bills start bein issued by the %ndian ovt. in 3435. They are short-term

instruments issued by the >eserve ank of %ndia. They are one of the safest money

market instruments because they are daner free, but the returns from this

instrument are not very hue. The primaries as well as the secondary markets

circulate this instrument. They have "-month, #-month and 3-year maturityperiods.

I >epurchase &reements

>epurchase areements are also known as repos. They are short-term loans that

buyers and sellers have consent to sell and repurchase. >epurchase areements are

sold by sellers with a assure of purchasin them back at a iven price and on a iven

date in the future. The buyer will also purchase the securities and other instruments

in the repurchase contract with a assure of sellin them back to the seller.

I 'ommercial 0apers

'ommercial papers are promissory notes that are unsecured and issued by

companies and financial institutions. They are issued at a discounted rate of their

face value. They have a fi/ed maturity of 3 to 65C days. They are issued forfinancin of inventories, accounts receivables, and settlin short-term liabilities or

loans. 'ommercial papers yield hiher returns than T-bills.

Meaning and %once&t of %a&ital Market

'apital Market is one of the sinificant aspect of every financial market. 1ence it is

necessary to study its correct meanin. roadly speakin the capital market is a market for

financial assets which have a lon or indefinite maturity. 8nlike money market instruments

the capital market intruments become mature for the period above one year. %t is an

institutional arranement to borrow and lend money for a loner period of time. %t consistsof financial institutions like %;%, %'%'%, 8T%, 7%', etc. These institutions play the role of

lenders in the capital market. usiness units and corporate are the borrowers in the capital

market. 'apital market involves various instruments which can be used for financial

transactions. 'apital market provides lon term debt and e!uity finance for the overnment

and the corporate sector. 'apital market can be classified into primary and secondary

markets. The primary market is a market for new shares, where as in the secondary market

the e/istin securities are traded. 'apital market institutions provide rupee loans, forein

e/chane loans, consultancy services and underwritin.

Functions of %a&ital Market

7et us et ac!uainted with the important functions and role of the capital market.

Mobili)ation of *a(ings9 'apital market is an important source for mobilizin idle savins

from the economy. %t mobilizes funds from people for further investments in the productive

channels of an economy. %n that sense it activate the ideal monetary resources and puts

them in proper investments.
http://kalyan-city.blogspot.com/2010/09/instruments-of-monetary-policy.htmlhttp://kalyan-city.blogspot.com/2010/09/instruments-of-monetary-policy.html


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%a&ital Formation 9 'apital market helps in capital formation. 'apital formation is net

addition to the e/istin stock of capital in the economy. Throuh mobilization of ideal

resources it enerates savins: the mobilized savins are made available to various

sements such as ariculture, industry, etc. This helps in increasin capital formation.

+ro(ision of In(estment '(enue9 'apital market raises resources for loner periods of

time. Thus it provides an investment avenue for people who wish to invest resources for a

lon period of time. %t provides suitable interest rate returns also to investors. %nstruments

such as bonds, e!uities, units of mutual funds, insurance policies, etc. definitely provides

diverse investment avenue for the public.

*&eed u& ,conomic ro.t/ and De(elo&ment9 'apital market enhances production

and productivity in the national economy. &s it makes funds available for lon period of

time, the financial re!uirements of business houses are met by the capital market. %t helps

in research and development. This helps in, increasin production and productivity in

economy by eneration of employment and development of infrastructure.

+ro&er 0egulation of Funds9 'apital markets not only helps in fund mobilization, but italso helps in proper allocation of these resources. %t can have reulation over the resources

so that it can direct funds in a !ualitative manner.

*er(ice +ro(ision9 &s an important financial set up capital market provides various types

of services. %t includes lon term and medium term loans to industry, underwritin services,

consultancy services, e/port finance, etc. These services help the manufacturin sector in a

lare spectrum.

%ontinuous '(ailability of Funds9 'apital market is place where the investment avenue

is continuously available for lon term investment. This is a li!uid market as it makes fund

available on continues basis. oth buyers and seller can easily buy and sell securities as

they are continuously available. asically capital market transactions are related to the

stock e/chanes. Thus marketability in the capital market becomes easy.

M2,3 M'04,T

%t is a centre in which financial institutions oin toether for the purpose

of dealin in financial or monetary assets, which may be of short term maturity or lon termmaturity. The short term means, enerally a period upto one year and the term near

substitutes to money, denotes any financial asset which can be !uickly converted into

money with minimum transaction cost.

Terms relating to Money Market

Money Market>efers to the market for short-term re!uirement and deployment of funds.%all MoneyMoney lent for one day

2otice MoneyMoney lent for a period e/ceedin one dayTerm MoneyMoney lend for 3$ days or more in %nter-bank market

5eld till maturity*ecurities which are not meant for sale and shall be kept till maturity5eld for trading *ecurities ac!uired by the banks with the intention to trade by takin


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advantae of the short-term priceJ interest rate movements will be classified under held fortradin.

'(ailable for saleThe securities which do not fall within the above two cateories i.e. 1TMor 1FT will be classified under available for sale.

3ield to maturity 2/pected rate of return on an e/istin security purchased from themarket

%ou&on 0ate*pecified interest rate on a fi/ed maturity security fi/ed at the time of issue.Treasury o&erationsTradin in overnment securities in the market. &n investor ank can

purchase these securities in the primary market. Tradin takes place in the secondarymarket.

ilt ,dged security?overnment security that is a claim on the overnment and is asecure financial instrument which uarantees certainty of both capital and interest. These

securities are free of default risk or credit risk, which leads to low market risk and hihli!uidity.

%'6672TI%, M2,3 M'04,T +,0'TI2* I2 I2DI'

The money market is a market for short-term financial assets that are close substitutes ofmoney. The most important feature of a money market instrument is that it is li!uid and

can be turned over !uickly at low cost and provides an avenue for e!uilibratin the short-term surplus funds of lenders and the re!uirements of borrowers. The callJnotice moneymarket forms an important sement of the %ndian money market. 8nder call money market,

funds are transacted on overniht basis and under notice money market, funds aretransacted for the period between 6 days and 3B days.

anks borrow in this money market for the followin propose.I To fill the aps or temporary mismatches in funds

I To meet the '>> K *7> Mandatory re!uirements as stipulated by the 'entral bankI To meet sudden demand for funds arisin out of lare outflows

Thus call money usually serves the role of e!uilibratin the short-term li!uidity position ofbanks

+artici&ants0articipants in callJnotice money market currently include banks, 0rimary ;ealers (0;s),development finance institutions, insurance companies and select mutual funds. Gf these,

banks and 0;s can operate both as borrowers and lenders in the market. ut non-bankinstitutions (such as all-%ndia F%s, select %nsurance 'ompanies or Mutual Funds), which have

been iven specific permission to operate in callJnotice money market can, however,operate as lenders only. o new non-bank institutions are permitted to operate (i.e., lend)

in the callJnotice money market with effect from May $, 6CC3. %n case any eliibleinstitution has enuine difficulty in deployin its e/cess li!uidity, >% may consider providin

temporary permission to lend a hiher amount in callJnotice money market for a specificperiod on a case-by-case basis.

2ffective from &u C#, 6CC$ non-bank participants e/cept 0rimary ;ealers are to

discontinue participate, to make the call money market pure inter-bank market.

+rudential norms of 0BI7endin of scheduled commercial banks, on a fortnihtly averae basis, should not e/ceed

6$ per cent of their capital fund. 1owever, banks are allowed to lend a ma/imum of $CD onany day, durin a fortniht.

orrowins by scheduled commercial banks should not e/ceed 3CC per cent of their capitalfund or 6 per cent of areate deposits, whichever is hiher. 1owever, banks are allowed

to borrow a ma/imum of 36$ per cent of their capital fund on any day, durin a fortniht.Interest 0ate

2liible participants are free to decide on interest rates in callJnotice money market.


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*co&e of India Money Market

The %ndia money market is a monetary system that involves the lendin and

borrowin of short-term funds. %ndia money market has seen e/ponential rowth ust

after the lobalization initiative in 3446. %t has been observed that financial

institutions do employ money market instruments for financin short-term monetary

re!uirements of various sectors such as ariculture, finance and manufacturin. Theperformance of the %ndia money market has been outstandin in the past 6C years.

'entral bank of the country - the >eserve ank of %ndia (>%) has always been playin

the maor role in reulatin and controllin the %ndia money market. The intervention

of >% is varied - curbin crisis situations by reducin the cash reserve ratio ('>>) or

infusin more money in the economy.

Ty&es of Money Market instruments in India -

Money market instruments take care of the borrowers= short-term needs and render

the re!uired li!uidity to the lenders. The varied types of %ndia money market instruments

are treasury bills, repurchase areements, commercial papers, certificate of deposit, andbanker=s acceptance.

Treasury Bills 8T-Bills - Treasury bills were first issued by the %ndian overnment in

3435. Treasury bills are short-term financial instruments that are issued by the 'entral

ank of the country. %t is one of the safest money market instruments as it is void of market

risks, thouh the return on investments is not that hue. Treasury bills are circulated by the

primary as well as the secondary markets. The maturity periods for treasury bills are

respectively "-month, #-month and 3-year. The price with which treasury bills are issued

comes separate from that of the face value, and the face value is achieved upon maturity.

Gn maturity, one ets the interest on the buy value as well. To be specific, the buy value is

determined by a biddin process, that too in auctions.

0e&urc/ase 'greements - >epurchase areements are also called repos. >epos are

short-term loans that buyers and sellers aree upon for sellin and repurchasin. >epo

transactions are allowed only amon >%-approved securities like state and central

overnment securities, T-bills, 0*8 bonds, F% bonds and corporate bonds. >epurchase

areements, on the other hand, are sold off by sellers, held back with a promise to

purchase them back at a certain price and that too would happen on a specific date. The

same is the procedure with that of the buyer, who purchases the securities and other

instruments and promises to sell them back to the seller at the same time.

%ommercial +a&ers -'ommercial papers are usually known as promissory notes which

are unsecured and are enerally issued by companies and financial institutions, at a

discounted rate from their face value. The fi/ed maturity for commercial papers is 3 to 65C

days. The purposes with which they are issued are - for financin of inventories, accounts

receivables, and settlin short-term liabilities or loans. The return on commercial papers is

always hiher than that of T-bills. 'ompanies which have a stron credit ratin, usually

issue '0s as they are not backed by collateral securities. 'orporations issue '0s for raisin

workin capital and they participate in active trade in the secondary market. %t was in 344C

that 'ommercial papers were first issued in the %ndian money market.


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%ertificate of De&osit -& certificate of deposit is a borrowin note for the short-term ust

similar to that of a promissory note. The bearer of a certificate of deposit receives interest.

The maturity date, fi/ed rate of interest and a fi/ed value - are the three components of a

certificate of deposit. The term is enerally between " months to $ years. The funds cannot

be withdrawn instantaneously on demand, but has the facility of bein li!uidated, if a

certain amount of penalty is paid. The risk associated with certificate of deposit is hiherand so is the return (compared to T-bills). %t was in 34A4 that the certificate of deposit was

first brouht into the %ndian money market.

Bankers 'cce&tance -& banker=s acceptance is also a short-term investment plan that

comes from a company or a firm backed by a uarantee from the bank. This uarantee

states that the buyer will pay the seller at a future date. Gne who draws the bill should have

a sound credit ratin. 4C days is the usual term for these instruments. The term for these

instruments can also vary between "C and 3AC days. %t is used as time draft to finance

imports, e/ports.

%t depends on the economic trends and market situation that >% takes a step forward to

ease out the disparities in the market. @henever there is a li!uidity crunch, the >% optseither to reduce the 'ash >eserve >atio ('>>) or infuse more money in the economic

system. %n a recent initiative, for overcomin the li!uidity crunch in the %ndian money

market, the >% infused more than >s 5$,CCC crore alon with reductions in the '>>.

Bond Market

The bond market (also known as the credit, or fi;ed income market) is a financialmarketwhere participants can issue new debt, known as the primary market, or buy and

sell debt securities, known as the *econdary market, usually in the form of bonds. Theprimary oal of the bond market is to provide a mechanism for lon term fundin of public

and private e/penditures. &s of 6CC4, the size of the worldwide bond market (total debt

outstandin) is an estimated


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?overnment K aency

Municipal

Mortae backed, asset backed, and collateralized debt obliation

Fundin

Bond market &artici&ants

ond market participants are similar to participants in most financial markets and are

essentially either buyers (debt issuer) of funds or sellers (institution) of funds and oftenboth.

0articipants include9

%nstitutional investors

?overnments

Traders

%ndividuals

ecause of the specificity of individual bond issues, and the lack of li!uidity in many smaller

issues, the maority of outstandin bonds are held by institutions like pension funds, banksand mutual funds. %n the 8nited *tates, appro/imately 3CD of the market is currently held

by private individuals.

Bond market size

&mounts outstandin on the lobal bond market increased by $D in 6C3C to a record


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International Bond Market is (ery big and /as an estimated si)e of nearly T/e si)e of t/e U* bond market is t/e largest in t/e .orld> T/e U*

bond markets outstanding debt is more t/an

The %nternational ond Market has rown double in size since the year 6CCC. y the end of

the year 6CC# it has been recorded that nearly


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Foreign Bonds

The forein bond market is that in which bonds are brouht out by forein borrowers. The

forein bonds are normally desinated in the local currency. The local market authorities

look after the issuin and sellin of forein bonds.

Foreign Bond Markets

The forein bonds are traded in the forein bond markets which constituted a sinificant

portion of the international bond market until a few decades ao. *ome definin

characteristics of the forein bond markets are9

%ssuers are normally overnments and private sector utilities such as the railway companies

%t was standard practice to underwrite as well as oranize underwritin risk

%ssues were pleded by the retail investors and the institutional investors

The structure of a forein bond at that time is similar to the present day forein bonds

'ontinental private banks and old merchant houses in 7ondon connected the investors and

the issuers

,urobonds

2urobonds differ from the others in that they are not sold in any particular national bond

market. 2urobonds are issued by a roup of multinational banks. %f a 2urobond is

desinated in any currency, it would be sold outside the country which uses that currency.

For e/ample if a 2urobond is denominated in the 8nited *tates dollar, it would not be sold in

the 8nited *tates.

,uromarket

The 2uromarket is the market where 2urobonds are traded apart from the 2urocurrency,

2uronotes, 2urocommercial 0apers, and 2uroe!uity. The 2uromarket is normally an offshore

market. The traders of bonds prefer the 2urobond market as it has comparatively lower

costs and reulations

Benc/ Mark Drill

& company that drills wells and tries to beat its previous performance in terms of

cost, drillin speed and success in reachin its obective will improve its operations. %t uses

its own performance as a benchmark. That same company miht do a lot better if itcompared its drillin performance with the best performances ever turned in for the same

tarets in the same eoraphical area. That new set of benchmarks lihts the way to an

even hiher level of performance.

&berdeen, *cotland=s >ushmore >eviews, which conducts benchmarkin of worldwide

drillin and completions operations outside orth &merica from 3$C companies in $C

countries, recently conducted its third annual est 0ractices in the enchmarkin of ;rillin


15/32

and 'ompletions conference with some of the best benchmark e/perts in the oil and as

industry as participants and speakers.

Using benc/marks

The benchmarkin studies ive us sufficient information to conduct important analysis andto shape our conversations with other operators on key issues, said ?abriel 1iuera,

drillin and completions performance specialist with 0 in &berdeen.

1elen >ushmore, director of >ushmore >eviews, said, @e are seein a real and increasin

determination amon the operators to drive performance improvement usin benchmarkin

data as a key tool.

0eter >ushmore said companies typically use benchmarkin in four prime-focus areas9

I for budetin and plannin for wells in new areas:

I for taret settin. %dentify the best-in-class well for a cateory and aim to beat it:

I To identify the specific performance aps between a client=s company and the best in thefield for !uick wins: and

I To identify the best-in-class operators, study what they do differently and then adapt and

adopt those best practices back home.

Gbectives vary, he said. *hell=s ;rillin the 7imit strives for perfection, but some *hell

divisions use benchmarkin to set real-life tarets that drillin crews will buy into. 0=s

eyond the est and ?reat Gperator prorams use benchmarkin to discover the best

performance and use that as a sprin board to match and beat. 2very 0 well has a best-

in-class well (normally drilled by another operator) tied to it, he added.

The rowth in the last decade in drillin and completions benchmarkin has beenimpressive but looks like bein ust the start as even more operators worldwide look to this

performance improvement methodoloy in their !uest for the perfect well.

%n the field

;urin the conference, Eimberly Mc1uh, lobal benchmarkin coordinator for 8nocal

'orp., said her company had used benchmarkin to help it slash drillin times for typical

33,5CC-ft (",$#A-m) deviated wells in the ?ulf of Thailand from almost 5C days to ust B

days since the 34ACs.

;edicated manaement principles, above-and-beyond technoloical advances, favorableconditions and teamwork throuhout the business unit have been the key to our success in

Thailand, she said.

International Bond Market

onds are an important source of lon term capital for firms. & bond is debt. & firm

(or overnment) issues a certificate, called a bond that states that the firm will make

cou&on &aymentsto the holder of the bond and will, at maturity pay the holder the &ar


16/32

(alueof the bond. 'oupon payments are simply the interest payments on the debt and the

par value is the principal. Firms sell these bonds to investors (thereby borrowin money).

The key difference between borrowin money by issuin bonds rather than borrowin

directly from a bank is that there e/ists a secondary marketfor bonds. That is, if you buy

a bond from a firm (lendin that firm money) you can later sell the bond to another

investor. The act of firms sellin bonds directly to investors is termed the &rimary market,while investors tradin bonds amon themselves is the secondary market.

There e/ists a well developed domestic market for bonds ('anadian firms issuin bonds

denominated in 'anadian dollars and sellin them in 'anada). 1owever, there also e/ists an

international bond market. The international bond market is really a set of loosely connected

individual markets around the world. There are many different bond markets in many

countries, taken toether as a whole they constitute the international bond market.

The international bond market can be broken down into two parts9

3) Forein onds

6) 2urobonds

1 Foreign bondsare simply bonds issued in a bond market by a forein company. For

e/ample, a Oapanese firm issuin a 8.*. dollar denominated bond in the 8.*. is issuin a

forein bond.

ecause forein bonds are simply a part of the domestic bond market, the only real

difference is their treatment under the law. %n many countries, forein bonds are subect to

different ta/ treatment, reistration re!uirements et cetera.

The most important forein bond markets are located in Purich, ew ork, Tokyo, Frankfurt,

7ondon and &msterdam.

The reasons that a company may o to another country to issue bonds include the simple

fact that there may not be enouh demand in the domestic market. ?oin to a forein

market opens up a whole new set of potential investors to the firm. For instance, a ?erman

pharmaceutical firm may wish to borrow ;M $CC million. 1owever, its investment bank tells

it that there is only demand for ;M 6$C million of its bonds. %n order to float the rest it

would have to offer a much hiher yield. ut, for some reason there is demand in the 8* for

the debt of pharmaceutical firms, and that demand is not bein met by 8* companies. The

?erman firm could then float an issue in ?ermany (in ;M) and also float an issue in the 8*

(in


17/32

Ta/onomy has arisen for forein bonds. Forein bonds issued in the 8.*. are termed

3ankee bonds: in Oapan they are called *amurai bonds, in 2nland Bulldog bondsand

in the etherlands 0embrandt bonds.

! ,urobondsare bonds denominated in one currency but issued in a country that is not

the home of that currency. For e/ample, a bond denominated in


18/32

outside the countries where the currencies are issued as leal tender.The market for

investments denominated in currencies other than the one in which the investment is

traded. For e/ample, a eurodollar is a 8.*. dollardeposit outside the urisdiction of the

Federal >eserve(that is, outside the 8nited *tates). 2urodollar investmentsmay be traded

in any country other than the 8nited *tates but are usually traded in 7ondon. 7ikewise, a

euroyen is a yen deposit outside Oapan, thouht it usually refers to a euroyen ';. Theeurocurrency market may also refer to the tradinof eurocurrency bonds. %t is important to

note that term has nothin to do with the euro, and the prefi/ euro- is used more

enerally to refer to deposits outside the urisdiction of the local central bank (e..

euroruble).The market where financial bankin institutions provide bankin services

denominated in forein currencies. They may accept deposits and provide loans. 8nlike

2urocredit markets, however, loans in this market are made short-term.

%/aracteristic of money market

%n9 usiness K Finance, %nvestin and Financial Markets, 2conomics, and Mutual Funds

,uro De&osit

Definition of ,uro De&osit

The e!uivalent of a money market rate on cash deposits made in the euro currency.

2uro deposit rates will usually be !uoted as money market euro deposit rates and

are typically only offered to 8.*. investors with minimum investments of reater than

3C,CCC euros. 2uro deposits pay a floatin interest rate (like a money market

account) and offer the chance for capital appreciation if the euro appreciates aainst

the investor=s home currency (presumably the dollar). 2uro deposit rates are based

on the euro interbank offer rate, which is set by the 2uropean 'entral ank.

*urplus 2uro funds can be safely and profitably invested, at a hiher interest rate than theone on siht deposits. ou can also choose special-purpose deposits.

@/o are t/ey intended forA

&ll domestic leal entities and sole proprietors who want to manae cash flows

economically.

Main ad(antages

*timulatin interest rate,

the possibility of makin a deposit in a lump sum or in instalments over a certain period,

Fle/ible maturity tailored to your needs.

Basic information

Maturity9 from " days to $ years,

Minimum de&osited amount9 28> 6$C (e/cept for special-purpose deposits).
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19/32

ersions of ,uro de&osits

Gverniht deposits for municipalities,

overniht deposits,

on-special-purpose and special-purpose deposits up to "C days,

on-special-purpose and special-purpose deposits for more than " days with notice period,

on-special-purpose and special-purpose deposits for more than "C days,

*pecial-purpose deposits.

,uro Dollars

,urodollars are time deposits denominated in 8.*. dollars at banks outside the 8nited*tates, and thus are not under theurisdictionof the Federal >eserve. 'onse!uently, such

deposits are subect to much less reulation than similar deposits within the 8.*., allowin

for hiher marins. The term was oriinally coined for 8.*. dollars in 2uropean banks, but ite/panded over the years to its present definitionQa 8.*. dollar-denominated deposit inTokyo or eiin would be likewise deemed a 2urodollar deposit. There is no connection with

the eurocurrency or the eurozone.

More enerally, the euro- prefi/ can be used to indicate any currency held in a country

where it is not the official currency9 for e/ample, euroyenor even euroeuro.L3

5o. t/e ,urodollar futures contract .orks

For e/ample, if on a particular day an investor buys a sinle three month contract at 4$.CC(implied settlement 7%G> of $.CCD)9if at the close of business on that day, the contract

price has risen to 4$.C3 (implyin a 7%G> decrease to B.44D), 8* increase to $.C3D), 8* fi/in forthat day rather than a market-determined contract price.*o far we have considered what

are known as domestic money market instruments. & domestic money market instrument isan instrument issued in its domestic currency. For e/ample, commercial paperissued by a

8* corporate and denominated in ;ollars, or a *terlin deposit held in 7ondon.

%f a money market instrument is issued in a forein currency it is known as a euro

instrument. For e/ample, a dollar denominated certificate of de&osit issued in 7ondon isknown as a euro ';, and a en deposit held in the account of a 7ondon bank, is known as a

2uroyen deposit.
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20/32

ote9 althouh the deposit is held in the account of a 7ondon bank the money doesnHt

actually leave Oapan: rather it is held in the account of a 7ondon based bank in Oapan and

becomes an asset of that bank. The depositorHs (investorHs) claim is with the 7ondon bank.

,uro-de&osits and ,uro 6oans

The 2uro market has its oriins in time deposits - whereby cash was held in a bankin

system outside the country of that currencyHs oriin.1istorically there was a demand for

dollars to be held in time deposits outside the 8*, specifically in 2urope, thus they came to

be called 2urodollars.;ollars later came to be held in *outh-2ast &sia and the Middle

2astern bankin systems, but they are still called 2urodollars. The market subse!uently

widened to include a rane of currencies held in time deposits outside their country of oriin- 2urodeutschmarks, 2uroyen and so on.

2uro time deposits enerally rane from 5 days to # months. anks receivin

2urocurrencies use them to make loans to international and supranational financial

institutions, overnments, companies and to each other. ank borrowin in 2urocurrency

markets is an alternative to borrowin in domestic interbank markets. & 2uroplacement is

an alternative to sellin reserves in the domestic interbank market.@ith the e/ception of

overniht funds, domestic and euro rates track each other closely. The euro rate tends to be

slihtly hiher because of the hiher risk attached to holdin currency in a forein country.

These risks include the possibility that the 'entral &uthority where the euro deposit is held

may interfere in the movement of interest or principal. &nother risk is that the 'entral ank

may not act as Rthe lender of last resortS to bail out a 2urobank (the bank where the deposit

is held) which ets into trouble.The risks of holdin euro-deposits are accentuated by the

fact that, on averae, euro-deposits tend to have shorter maturities than euro-loans.

2uro-deposits are free from reserve re!uirements and most other national reulations, and

as their attractiveness for heders and speculators moves funds into the market, 'entral

ank control of financial intermediaries declines.

2uro securities

&s well as euro deposits, money market securities can be euro securities. *uch securities

include9

euro commercial paper (2'0),

euro certificates of deposit (euro ';),

euronotes:

and international repos.


21/32

Unit II

Definition of Monetary

>elatin to money, or to the mechanismsby which it is supplied to, andcirculates in, an economy. %n comparison, fiscal relates to public revenues (ta/ation) and

public spendin, debt, and finance.%n our time, the curse is monetary illiteracy, ust asinability to read plain print was the curse of earlier centuries.The reulationof the money

supplyand interest ratesby a central bank, such as the Federal >eserve oardin the 8.*.,in orderto control inflationand stabilize currency. Monetarypolicyis one the two ways the

overnmentcan impact the economy. y impactin the effective cost of money, the Federal>eserve can affectthe amountof moneythat is spent by consumersand businesses.

monetary - relatin to or involvin money: monetary rewards:

International monetary system

Definition

?lobal payment system comprisin of financial institutions, electronic

networks, conventions, and areed upon rules, for the smoothfunctionin of international trade.%nternational monetary system, rules

and procedures by which different national currencies are e/chaned for each other inworld trade. *uch a system is necessary to define a common standard of value for the

world=s currencies.

International monetary systemsare sets of internationally areed rules, conventions

and supportin institutions that facilitate international trade, cross border investmentand

enerally the reallocation of capitalbetween nation states. They provide means of payment

acceptable between buyers and sellers of different nationality, includin deferred payment.

To operate successfully, they need to inspire confidence, to provide sufficient li!uidity for

fluctuatin levels of trade and to provide means by which lobal imbalances can be

corrected. The systems can row oranically as the collective result of numerous individual

areements between international economic actors spread over several decades.

&lternatively, they can arise from a sinle architectural vision as happened at retton
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@oods in 34BB.%nternational monetary system, rules and procedures by which different

national currencies are e/chaned for each other in world trade. *uch a system is necessary

to define a common standard of value for the world=s currencies.

The International Monetary Fund(IMF) is an oranization of 3A5 countries, workin to

foster lobal monetary cooperation, secure financial stability, facilitate international trade,promote hih employment and sustainable economic rowth, and reduce poverty around

the world. The oranization=s stated obectives are to promote international economiccooperation, international trade, employment, and e/chane rate stability, includin by

makin resources available to member countries to meet balance of paymentsneeds. %tshead!uarters are in @ashinton, ;.'..

The %MF was conceived on Ouly 66, 34BB oriinally with B$ members and came intoe/istence on ;ecember 65, 34B$ when 64 countries sined the areement, with a oal to

stabilize e/chane rates and assist the reconstruction of the worldHs international payment

system. 'ountries contributed to a pool which could be borrowed from, on a temporarybasis, by countries with payment imbalances. The %MF works to improve the economies of

its member countries. The %MF describes itself as Ran oranization of 3A5 countries (as of

Ouly 6C3C), workin to foster lobal monetary cooperation, secure financial stability,facilitate international trade, promote hih employment and sustainable economic rowth,

and reduce poverty.S

Functions of t/e IMF

%MF describes itself as an oranization of 3AB countries, workin to foster lobal monetarycooperation, secure financial stability, facilitate international trade, promote hih

employment and sustainable economic rowth, and reduce poverty.

The primary mission of the %MF is to provide financial assistance to countries that

e/perience serious financial difficulties. Member states with balance of payments problems

may re!uest loans andJor oranizational manaement of their national economies. %nreturn, the countries are usually re!uired to launch certain reforms, an e/ample of which isthe @ashinton 'onsensus. These reforms are enerally re!uired because countries with

fi/ed e/chane rate policies can enae in fiscal, monetary, and political practices whichmay lead to the crisis itself. For e/ample, nations with severe budet deficits, rampant

inflation, strict price controls, or sinificantly over-valued or under-valued currencies run therisk of facin balance of payment crises in their future. Thus, the structural adustment

prorams are at least ostensibly intended to ensure that the %MF is actually helpin toprevent financial crises rather than merely fundin financial recklessness.

(%MF) is an international oranization that provides financial assistance and advice tomember countries. This article will discuss the main functions of the oranization, which has

become an endurin institution interal to the creation of financial markets worldwide and tothe rowth of developin countries.

@/at Does It DoA

The %MF was born at the end of @orld @ar %%, out of the retton @oods'onference in

34B$. %t was created out of a need to prevent economic crises like the ?reat ;epression.@ith its sister oranization, the @orld ank, the %MF is the larest public lender of funds in

the world. %t is a specialized aency of the 8nited ations and is run by its 3A# member

countries. Membership is open to any country that conducts forein policy and accepts the
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oranization=s statutes.

The %MF is responsible for the creation and maintenance of the international monetarysystem, the system by which international payments amon countries take place. %t thus

strives to provide a systematic mechanism for forein e/chanetransactions in order tofoster investment and promote balanced lobal economic trade.

To achieve these oals, the %MF focuses and advises on the macroeconomicpolicies of a

country, which affect its e/chane rate and its overnment=s budet, money and creditmanaement. The %MF will also appraise a country=s financial sector and its reulatory

policies, as well as structural policies within the macroeconomy that relate to the labormarket and employment. %n addition, as a fund, it may offer financial assistance to nations

in need of correctin balance of paymentsdiscrepancies. The %MF is thus entrusted withnurturin economic rowth and maintainin hih levels of employment within countries.

5o. Does It @orkAThe %MF ets its money from !uota subscriptions paid by member states. The size of each

!uota is determined by how much each overnment can pay accordin to the size of itseconomy. The !uota in turn determines the weiht each country has within the %MF - and

hence its votin rihts - as well as how much financin it can receive from the %MF.

Twenty-five percent of each country=s !uota is paid in the form of special drawin rihts(*;>s), which are a claim on the freely usable currencies of %MF members. efore *;>s,

the retton @oods system had been based on a fi/ed e/chane rate, and it was feared thatthere would not be enouh reserves to finance lobal economic rowth. Therefore, in 34#A,

the %MF created the *;>s, which are a kind of international reserve asset. Theywere created to supplement the international reserves of the time, which were old and the

8.*. dollar. The *;> is not a currency: it is a unit of account by which member states cane/chane with one another in order to settle international accounts. The *;> can also be

used in e/chane for other freely-traded currencies of %MF members. & country may do thiswhen it has a deficit and needs more forein currency to pay its international obliations.

The *;>=s value lies in the fact that member states commit to honor their obliations to use

and accept *;>s. 2ach member country is assined a certain amount of *;>s based on howmuch the country contributes to the Fund (which is based on the size of the country=s

economy). 1owever, the need for *;>s lessened when maor economies dropped the fi/ede/chane rate and opted for floatin rates instead. The %MF does all of its accountin in

*;>s, and commercial banks accept *;> denominated accounts. The value of the *;> is

adusted daily aainst a basket of currencies, which currently includes the 8.*. dollar, theOapanese yen, the euro, and the ritish pound.

The larer the country, the larer its contribution: thus the 8.*. contributes about 3AD of

total !uotas while the *eychelles %slands contribute a modest C.CCBD. %f called upon by the%MF, a country can pay the rest of its !uota in its local currency. The %MF may also borrowfunds, if necessary, under two separate areements with member countries. %n total, it has

*;> 636 billion (8*; 64C billion) in !uotas and *;> "B billion (8*; B# billion) available toborrow.

IMF Benefits

The %MF offers its assistance in the form of surveillance, which it conducts on a yearly basisfor individual countries, reions and the lobal economy as a whole. 1owever, a country
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may ask for financial assistance if it finds itself in an economic crisis, whether caused by asudden shock to its economy or poor macroeconomic plannin. & financial crisis will result in

severe devaluation of the country=s currency or a maor depletion of the nation=s foreinreserves. %n return for the %MF=s help, a country is usually re!uired to embark on an %MF-

monitored economic reform proram, otherwise known as *tructural &dustment 0olicies(*&0s). (For more insiht,There are three more widely implemented facilities by which the

%MF can lend its money. & stand-by areement offers financin of a short-term balance ofpayments, usually between 36 to 3A months. The e/tended fund facility (2FF) is a medium-

term arranement by which countries can borrow a certain amount of money, typically overa three- to four-year period. The 2FF aims to address structural problems within the

macroeconomy that are causin chronic balance of paymentine!uities. The structuralproblems are addressed throuh financial and ta/ sector reform and the privatization of

public enterprises. The third main facility offered by the %MF is known as the povertyreduction and rowth facility (0>?F). &s the name implies, it aims to reduce poverty in the

poorest of member countries while layin the foundations for economic development. 7oansare administered with especially low interest rates. (For related readin, check out @hat %s

The alance Gf 0ayments)

The %MF also offers technical assistance to transitional economies in the chaneover

from centrally plannedto market run economies. The %MF also offers emerency funds tocollapsed economies, as it did for Eorea durin the 3445 financial crisis in &sia. The fundswere inected into Eorea=s forein reserves in order to boost the local currency, thereby

helpin the country avoid a damain devaluation. 2merency funds can also be loaned tocountries that have faced economic crisis as a result of a natural disaster. (For a better look

at how economies make the transition from bein state run to free markets, see *tate->un2conomies9 From 0rivate To 0ublic.)

&ll facilities of the %MF aim to create sustainable development within a country and try to

create policies that will be accepted by the local populations. 1owever, the %MF is not an aidaency, so all loans are iven on the condition that the country implement the *&0s and

make it a priority to pay back what it has borrowed. 'urrently, all countries that are under

%MF prorams are developin, transitional and emerin market countries (countries thathave faced financial crisis).

I2T,02'TI2'6 FI2'2%I'6 ,2I02M,2T

The %nternational Financial Flows and 2nvironment 0roect (%FF2) works to improve theenvironmental and social decision makin and performance of public and private

%nternational Financial %nstitutions (%F%s) by holdin them accountable to their investors, todonor countries and to the communities that are impacted by their investments.

*uccessful solutions to serious lobal challenes, such as combatin climate chane andprotectin human rihts, cannot be divorced from the issue of financin. %nternational

Financial %nstitutions (%F%s) are in a uni!ue position: they can continue to drive investmentsin a conventional Rbusiness as usualS manner or they can take an alternative approach and

raise environmental and social standards throuh their lendin practices.

>esources on 'limate Finance

>esources on 2merin &ctors in ;evelopment Finance

The role of public and private %F%s in development finance has reatly evolved over the past

two decades. %n 3446, public financial flows were reater than private financial flows:
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however, by 344#, private financial flows were more than $ times larer (?anzi et. al,344A). &s this trend continued throuh the late 344CHs and into the 6CCCHs, a fundamental

need arose for reater transparency and public participation in policy surroundin %F%investments. *ince 3445, %FF2, the @orld >esources %nstituteHs *ustainable Finance

%nitiative, has been leverain @>% e/pertise in biodiversity, climate chane, enery, andovernance to shape the environmental and social policies of %F%s.

&n international oranization whose purpose is to ensure the stability of the internationalfinancial system. *pecifically, the %MF promotes international monetary cooperation,

international trade, and e/chane rate stability: the oranization also assists membercountries that are havin trouble payin their debt obliations. The %MF was first proposed

in Ouly 34BB at a 8nited ations conference held at retton @oods, .1. Those at the

conference were lookin for a way to cooperate economically in order to avoid another?reat ;epression. The oranization came into e/istence on ;ecember 65, 34B$, when its

articles of areement were sined. %t bean financial operations on March 3, 34B5.

The %MF is composed of 3AB countries. %t is manaed by an 2/ecutive oard consistin of 6B2/ecutive ;irectors, head-!uartered in @ashinton, ;.'. %ts 2/ecutive oard meets as least

three times a week in formal sessions. Today, the %MF has three main functions. Gne is toappraise its membersH e/chane rate policies, in what is called an &rticle %+ consultation.

The %MF surveys its membersH economic and e/chane rate policies because it believes thiswill lead to stable e/chane rates and a rowin world economy. The %MF also provides

financial and technical assistance to member countries.

Balance of &ayments

Balance of &ayments 8B+ accounts are an accountin record of all monetarytransactions between a country and the rest of the world. These transactions include

payments for the country=s e/ports and imports of oods, services, financial capital, and

financial transfers. The o0 accounts summarize international transactions for a specificperiod, usually a year, and are prepared in a sinle currency, typically the domestic

currency for the country concerned. *ources of funds for a nation, such as e/ports or the

receipts of loans and investments, are recorded as positive or surplus items. 8ses of funds,such as for imports or to invest in forein countries, are recorded as neative or deficit

items.

@hen all components of the G0 accounts are included they must sum to zero with no

overall surplus or deficit. For e/ample, if a country is importin more than it e/ports, itstrade balance will be in deficit, but the shortfall will have to be counter-balanced in other

ways U such as by funds earned from its forein investments, by runnin down central bankreserves or by receivin loans from other countries.

@hile the overall G0 accounts will always balance when all types of payments are included,

imbalances are possible on individual elements of the G0, such as the current account, thecapital account e/cludin the central bank=s reserve account, or the sum of the two.%mbalances in the latter sum can result in surplus countries accumulatin wealth, while

deficit nations become increasinly indebted. The term balance of payments often refersto this sum9 a country=s balance of payments is said to be in surplus (e!uivalently, the

balance of payments is positive) by a certain amount if sources of funds (such as e/port

oods sold and bonds sold) e/ceed uses of funds (such as payin for imported oods andpayin for forein bonds purchased) by that amount. There is said to be a balance of
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payments deficit (the balance of payments is said to be neative) if the former are less thanthe latter.

8nder a fi/ed e/chane ratesystem, the central bank accommodates those flows by buyinup any net inflow of funds into the country or by providin forein currency funds to the

forein e/chane marketto match any international outflow of funds, thus preventin the

funds flows from affectin the e/chane ratebetween the country=s currency and othercurrencies. Then the net chane per year in the central bank=s forein e/chane reserves issometimes called the balance of payments surplus or deficit. &lternatives to a fi/ed

e/chane rate system include a manaed floatwhere some chanes of e/chane rates areallowed, or at the other e/treme a purely floatin e/chane rate(also known as a purely

fle/ible e/chane rate). @ith a pure float the central bank does not intervene at all to

protect or devalue its currency, allowin the rate to be set by the market, and the centralbank=s forein e/chane reserves do not chane.

%auses of B+ imbalances

There are conflictin views as to the primary cause of G0 imbalances, with much attention

on the 8* which currently has by far the biest deficit. The conventional view is thatcurrent account factors are the primary cause - these include the e/chane rate, theovernment=s fiscal deficit, business competitiveness, and private behaviour such as the

willinness of consumers to o into debt to finance e/tra consumption. &n alternative view,arued at lenth in a 6CC$ paper by en ernanke, is that the primary driver is the capital

account, where a lobal savins lutcaused by savers in surplus countries, runs ahead ofthe available investment opportunities, and is pushed into the 8* resultin in e/cess

consumption and asset price inflation.

Balance of &ayments crisis

& G0 crisis, also called a currency crisis, occurs when a nation is unable to pay for essential

imports andJor service its debt repayments. Typically, this is accompanied by a rapid declinein the value of the affected nation=s currency. 'rises are enerally preceded by lare capitalinflows, which are associated at first with rapid economic rowth.1owever a point is reached

where overseas investors become concerned about the level of debt their inbound capital iseneratin, and decide to pull out their funds. The resultin outbound capital flows are

associated with a rapid drop in the value of the affected nation=s currency. This causesissues for firms of the affected nation who have received the inbound investments and

loans, as the revenue of those firms is typically mostly derived domestically but their debts

are often denominated in a reserve currency. Gnce the nation=s overnment has e/haustedits forein reserves tryin to support the value of the domestic currency, its policy options

are very limited. %t can raise its interest rates to try to prevent further declines in the value

of its currency, but while this can help those with debts in denominated in foreincurrencies, it enerally further depresses the local economy

Milton Friedmanaruin that there was no reat need to be concerned about G0 issues.&ccordin to >othbard9

Fortunately, the absurdity of worryin about the balance of payments is made evident by

focusin on inter-state trade. For nobody worries about the balance of payments between

ew ork and ew Oersey, or, for that matter, between Manhattan and rooklyn, because

there are no customs officials recordin such trade and such balances.
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The balance of payments(G0) is the method countries use to monitor all internationalmonetary transactions at a specific period of time. 8sually, the G0 is calculated every

!uarter and every calendar year. &ll trades conducted by both the private and public sectorsare accounted for in the G0 in order to determine how much money is oin in and out of

a country. %f a country has received money, this is known as a credit, and, if a country haspaid or iven money, the transaction is counted as a debit. Theoretically, the G0 should be

zero, meanin that assets (credits) and liabilities (debits) should balance. ut in practicethis is rarely the case and, thus, the G0 can tell the observer if a country has a deficit or a

surplus and from which part of the economy the discrepancies are stemmin.alance of payments issues

1istorically, accurate balance of payments fiures were not enerally available. 1owever,

this did not prevent a number of switches in opinion on !uestions relatin to whether or nota nations overnment should use policy to encourae a favourable balance.

+re-1!C: mercantilism

8p until the early 34th century, international trade was enerally very small in comparison

with national output, and was often heavily reulated. %n the Middle &es, 2uropean tradewas typically reulated at municipal level in the interests of security for local industry andfor established merchants. From about the 3#th century, mercantilism became the

dominant economic theory influencin 2uropean rulers, which saw local reulation replacedby national rules aimin to harness the countries= economic output. Measures to promote a

trade surplus such as tariffs were enerally favoured. 0ower was associated with wealth,and with low levels of rowth, nations were best able to accumulate funds either by runnin

trade surpluses or by forcefully confiscatin the wealth of others. >ulers sometimes strove

to have their countries outsell competitors and so build up a war chest of old.

This era saw low levels of economic rowth: averae lobal per capita income is notconsidered to have sinificantly risen in the whole ACC years leadin up to 3A6C, and is

estimated to have increased on averae by less than C.3D per year between 35CC and3A6C. @ith very low levels of financial interation between nations and with international

trade enerally makin up a low proportion of individual nations= ?;0, G0 crises were veryrare.

1!C191$: free trade

?old was the primary reserve asset durin the old standard era.

From the late 3Ath century, mercantilism was challened by the ideas of &dam *mithandother economic thinkers favourin free trade. &fter victory in the apoleonic wars ?reat
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ritain bean promotin free trade, unilaterally reducin her trade tariffs. 1oardin of oldwas no loner encouraed, and in fact ritain e/ported more capital as a percentae of her

national income than any other creditor nation has since. ?reat ritain=s capital e/portsfurther helped to correct lobal imbalances as they tended to be counter cyclical, risin

when ritain=s economy went into recession, thus compensatin other states for income lostfrom e/port of oods.

&ccordin to historian 'arroll Nuiley, ?reat ritain could afford to act benevolently in the34th century due to the advantaes of her eoraphical location, her naval power and her

economic ascendancy as the first nation to enoy an industrial revolution. & view advancedby economists such as arry 2ichenreenis that the first ae of ?lobalizationbean with

the layin of transatlantic cables in the 3A#Cs, which facilitated a rapid increase in the

already rowin trade between ritain and &merica

Thouh 'urrent &ccount controls were still widely used (in fact all industrial nations apartfrom ?reat ritain and the etherlands actually increased their tariffs and !uotas in the

decades leadin up to 343B, thouh this was motivated more by a desire to protect infantindustries than to encourae a trade surplus), capital controlswere larely absent, and

people were enerally free to cross international borders without re!uirin passports.

& old standard enoyed wide international participation especially from 3A5C, further

contributin to close economic interation between nations. The period saw substantiallobal rowth, in particular for the volume of international trade which rew tenfold between

3A6CU3A5C and then by about BD annually from 3A5C to 343B. G0 crises bean to occur,thouh less fre!uently than was to be the case for the remainder of the 6Cth century. From

3AAC - 343B, there were appro/imately A G0 crises and A twin crises - a twin crises beina G0 crises that coincides with a bankin crises.

191$19$?: de-globalisation

The favorable economic conditions that had prevailed up until 343B were shattered by thefirst world war, and efforts to re-establish them in the 346Cs were not successful. *everalcountries reoined the old standard around 346$. ut surplus countries didn=t play by the

rulessterilisinold inflows to a much reater deree than had been the case in the pre-war period. ;eficit nations such as ?reat ritain found it harder to adust by deflation as

workers were more enfranchised and unions in particular were able to resist downwardspressure on waes. ;urin the ?reat ;epression most countries abandoned the old

standard, but imbalances remained an issue and international trade declined sharply. Therewas a return to mercantilist type bear thy neihbour policies, with countries

competitively devaluin their e/chane rates, thus effectively competin to e/portunemployment. There were appro/imately 3# G0 crises and 3$ twin crises (and a

comparatively very hih level of bankin crises.)

19$?19=1: Bretton @oods

Main article9 retton @oods system

Followin @orld @ar %%, the retton @oods institutions (the %nternational Monetary Fund

and @orld ank) were set up to support an international monetary systemdesined toencourae free trade while also offerin states options to correct imbalances without havin

to deflate their economies. Fi/ed but fle/ible e/chane rates were established, with the

system anchored by the dollar which alone remained convertible into old. The retton
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