International 001

01 Global financial system The global financial system (GFS) is a financial system consisting of institutions and regulations that act on the international level, as opposed to those that act on a national or regional level. The main players are the global institutions, such as International Monetary Fund and Bank for International Settlements, national agencies and government departments, e.g., central banks and finance ministries, and private institutions acting on the global scale. 1.1 International institutions The most prominent international institutions are the IMF, the World Bank and the WTO: •

The International Monetary Fund keeps account of international balance of payments accounts of member states. The IMF acts as a lender of last resort for members in financial distress, e.g., currency crisis, problems meeting balance of payment when in deficit and debt default. Membership is based on quotas, or the amount of money a country provides to the fund relative to the size of its role in the international trading system.

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The World Bank aims to provide funding, take up credit risk or offer favorable terms to development projects mostly in developing countries that couldn't be obtained by the private sector. The other multilateral development banks and other international financial institutions also play specific regional or functional roles.

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The World Trade Organization settles trade disputes and negotiates international trade agreements in its rounds of talks

Government institutions Governments act in various ways as actors in the GFS: they pass the laws and regulations for financial markets and set the tax burden for private players, e.g., banks, funds and 1

exchanges. They also participate actively through discretionary spending. They are closely tied to central banks that issue government debt, set interest rates and deposit requirements, and intervene in the foreign exchange market. Private participants Players acting in the stock-, bond-, foreign exchange-, derivatives- and commoditiesmarkets and investment banking are  Commercial banks  Pension funds  Hedge funds and private equity

02 Managing foreign exchange 02.1. How do central banks manage exchange rates? Foreign exchange market and management of exchange rate of a country’s currency are two key areas that influence the economic well-being of the general public. The exchange rate of a country’s currency is the value of its money for international trade in goods, services and finance and, therefore, it is part and parcel of the monetary condition of a country. Therefore, the central banks being the monetary authorities have been given discretionary powers under the relevant statutes to decide appropriate foreign exchange policies along with its monetary, financial and economic development policies. In macroeconomic perspective, foreign exchange policies are instrumental in mobilization of foreign savings and capital to fill the domestic resource gap and expand investments. Various public views are often expressed as to how the central banks should decide exchange rate policies and what factors should be taken into consideration. Therefore, this article is intended to educate the public on the background how the central banks manage or regulate exchange rates and foreign exchange markets.

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2.2 Why exchange rates? An exchange rate is a price of a currency stated in units of another currency, i.e., Rs 108 a US Dollar (US $), US$ 1.5 a Euro or Chinese Yuan 7 a US$. The exchange rate between two currencies can be stated in two ways, domestic currency price of foreign currency or foreign currency price of domestic currency, i.e., Rs. 108 a US$ or US$ 0.01 a Rupee. Exchange rates exist because countries have to exchange their national currencies with foreign currencies to engage in trade and financial transactions with other countries. For example, when a Sri Lankan garment manufacturer exports garments to a buyer in US, Sri Lankan exporter receives the payment for his export in US$. Therefore, if the Sri Lankan exporter is to use his US$ income in Sri Lanka, he has to sell his US$ proceeds to a bank for Sri Lanka Rupees. Similarly, Sri Lankan importers have to buy currencies of the exporting countries for payments to suppliers in those countries. Accordingly, any foreign receipts to a country involve supply of foreign currencies (or foreign exchange) in exchange for domestic currency. On the other hand, any payments to foreign countries involve purchase (demand for) of foreign currencies by paying in the domestic currency. In addition, certain authorized parties undertake dealings (buying and selling) in foreign currencies seeking various kinds of financial gain. Since international transactions are conducted in major foreign currencies such as US$, Sterling Pounds, Yen and Euro, market participants and policymakers are concerned about the exchange rates of such major currencies. In Sri Lanka, the Central Bank (CBSL) monitors mainly the exchange rate for US$ as the Base Exchange rate in the foreign exchange market. However, CBSL has designated several foreign currencies for international transactions by the public through banks. 2.3 What determines the exchange rates?

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Exchange Rates are determined by supply and demand side factors. For example, increased demand for sterling will cause an appreciation in the Sterling exchange rate. These are some of the most significant factors in exchange rate determination: 1. Interest Rates. 2. Relative inflation Rates. 3. Balance of Payments. 4. Speculative buying. 5. Public debt 6. Political stability and economic performance 2.4 Why exchange rates are important? The changes in exchange rates will have both favorable and unfavorable impacts on economic activities and living standard of the public because of the largely globalised trade and finance involving exchange of currencies. In general, appreciation of a country’s currency will have the following effects whereas depreciation will have the opposite effects. •

Lowering the domestic prices of imports because the cost of imports in domestic currency will be less due to higher value of the domestic currency, i.e., to pay for any given foreign price of imports will require less units of domestic currency. As a result, inflation will be lower depending on the extent of the imports in the domestic consumption and production activities.

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Country’s outstanding foreign debt equivalent of domestic currency will be lower and, therefore, burden on foreign debt repayment will less.

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One unfavorable effect will be that the lower import prices will encourage imports and worsen the country’s trade balance (net position between exports and imports).

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Another unfavorable effect will be that exporters will be discouraged by reduction in their income in domestic currency which will adversely affect the export 4

industries. However, if domestic inflation will be lower due to reduced import prices, there will be higher foreign demand for exports which will off-set the initial reduction in exporters’ income. However, there is no any acceptable economic model to determine whether appreciation or depreciation is better for a country since each will have both favorable and unfavorable effects in the short run and in the long run, depending on the economic conditions and priorities prevailing at times. Therefore, the policymakers tend to adopt from time to time certain policies to permit the currency to depreciate or appreciate depending on the economic policy priorities. If the country has a foreign reserves problem and needs to encourage exports while discouraging imports, it is conventional to adopt a policy to permit the currency depreciation. Such policies include exchange rate determination system permitted and specific measures introduced from time to time within the permitted exchange rate system. 2.5 Direct foreign exchange The foreign exchange market is where currency trading takes place. FX transactions typically involve one party purchasing a quantity of one currency in exchange for paying a quantity of another. Today FX market is one of the largest and most liquid financial markets in the world, and includes trading between large banks, central banks, currency speculators, corporations, governments, and other institutions. The average daily volume in the global foreign exchange and related markets is continuously growing. Traditional daily turnover was reported to be over US$ 3.2 trillion in April 2007 by the Bank for International Settlements. Since then, the market has continued to grow. The purpose of FX market is to facilitate trade and investment. The need for a foreign exchange market arises because of the presence of multifarious international currencies such as US Dollar, Pound Sterling, etc, and the need for trading in such currencies. The foreign exchange market is unique because of its trading volumes, 5

The extreme liquidity of the market,  

The large number of, and variety of, traders in the market,

 

Its geographical dispersion,

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Its long trading hours: 24 hours a day except on weekends

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The variety of factors that affect exchange rates.

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The low margins of profit compared with other markets of fixed

income 

The use of leverage

2.6 Market participants 

Banks

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Commercial companies

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Central banks

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Hedge funds as speculators

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Investment management firms

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Retail foreign exchange brokers 01 retail foreign exchange brokers 02 market makers.

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Other

2.7 Financial instruments 

Spot

A spot transaction is a two-day delivery transaction, as opposed to the futures contracts, which are usually three months. This trade represents a “direct exchange” between two 6

currencies, has the shortest time frame, involves cash rather than a contract; and interest is not included in the agreed-upon transaction. The data for this study come from the spot market. Spot transactions have the second largest turnover by volume after Swap transactions among all FX transactions in the Global FX market. 

Forward

One way to deal with the Foreign exchange risk is to engage in a forward transaction. In this transaction, money does not actually change hands until some agreed upon future date. A buyer and seller agree on an exchange rate for any date in the future, and the transaction occurs on that date, regardless of what the market rates are then. The duration of the trade can be a few days, months or years. 

Future

Foreign currency futures are exchange traded forward transactions with standard contract sizes and maturity dates. Futures are standardized and are usually traded on an exchange created for this purpose. The average contract length is roughly 3 months. Futures contracts are usually inclusive of any interest amounts. 

Swap

The most common type of forward transaction is the currency swap. In a swap, two parties exchange currencies for a certain length of time and agree to reverse the transaction at a later date. These are not standardized contracts and are not traded through an exchange. 

Option

A foreign exchange option is a derivative where the owner has the right but not the obligation to exchange money denominated in one currency into another currency at a pre-agreed exchange rate on a specified date. The FX options market is the deepest, largest and liquid market for options of any kind in the world. 7

2.8 Main currencies used in foreign exchange:  The U.S. Dollar The United States dollar is the world's main currency. All currencies are generally quoted in U.S. dollar terms. Under conditions of international economic and political unrest, the U.S. dollar has been the main safe-haven currency, which was proven particularly well during the Southeast Asian crisis of 1997-1998.  The Euro € The euro is the official currency of 16 out of 27 member states of the European Union (EU). The states, known collectively as the Euro zone The currency is also used in five further countries and territories with formal agreements and six other countries without such agreements. Hence it is the single currency for over 327 million Europeans. The euro was introduced to world financial markets as an accounting currency on 1 January 1999, replacing the former European Currency Unit (ECU) at a ratio of 1:1. Physical coins and banknotes entered circulation on 1 January 2002.  The Japanese Yen The Japanese yen is the third most traded currency in the world; it has a much smaller international presence than the U.S. dollar or the euro. The yen is very liquid around the world, practically around the clock. The natural demand to trade the yen concentrated mostly among the Japanese keiretsu, the economic and financial conglomerates.  The British Pound

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The pound is the currency of the united kingdom .The currency is heavily traded against the euro and the U.S. dollar, but has a spotty presence against other currencies. Sterling is currently the third-largest reserve currency, after the US dollar and the euro.[3] The pound sterling is the fourth-most-traded currency in the foreign exchange market after the US dollar, the euro, and the Japanese yen.[4]  The Swiss Franc The Swiss franc is the only currency of a major European country that belongs neither to the European Monetary Union nor to the G-7 countries. Although the Swiss economy is relatively small, the Swiss franc is one of the four major currencies, closely resembling the strength and quality of the Swiss economy and finance. Typically, it is believed that the Swiss franc is a stable currency. Actually, from a foreign exchange point of view, the Swiss franc closely resembles the patterns of the euro, but lacks its liquidity. As the demand for it exceeds supply, the Swiss franc can be more volatile than the euro.

03 Bills of Exchange The most common and yet most complex form of negotiable instrument used for business transactions is known as the draft, or the bill of exchange. A bill of exchange can be used for payment, credit, or security in a financial transaction. The term comes from the English and is defined as an unconditional order in writing that is addressed by one person to another and signed by the person giving it. In a bill of exchange transaction, a person, or the drawer, agrees to pay to another, also known as the drawer , a sum of money at a given date, usually three months ahead. In principle, the bill of exchange operates much a like a postdated check in that it can be endorsed for payment to the bearer or any other person named other than the drawer.

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If the person accepts the bill of exchange by signing his name, or his name with the word "accepted," across the face of the paper, he is called an acceptor. The person to whom a bill is transferred by the acceptor's endorsement is called the endorsee. Any person in possession of a bill, whether as payee, endorsee, or bearer, is termed a holder. The basic rule applying to bills of exchange is that any signature appearing on a bill obligates the signer to pay the specified amount drawn on the bill. The bill of exchange then must be accepted or "endorsed" by an accepting house, an institution that deals exclusively with bills of exchange, such as a bank, or a trader. Once the bill is accepted, the drawee does not have to wait for the bill to mature before receiving his funds. If he so chooses, the drawee can also sell the bill on the money market for a small discount. A bill of exchange can also be passed beyond the drawer, drawee, and creditor. For the purposes of payment or borrowing, the creditor may transfer the bill of exchange to a fourth party, who in turn may pass it on and on through endorsement or signature of the transferor. Endorsement transfers the rights of the endorser to the new holder and also creates a liability of the endorser for payment of the amount of the draft if the drawee does not meet payment when the draft is due. A failure to pay a draft must be more or less formally recognized, and the draft holder may claim payment from any endorser whose signature appears on the instrument. 3.1 Characteristics of Bills of exchange  incorporation,  literality,  abstraction,  Autonomy.

Incorporation Incorporation means that the obligation is incorporated in the instrument. In other words, who owns the document owns the right, meaning that it is enough to be the legitimate holder upon a continuous series of endorsements to have the right to claim and receive 10

payment. This is so important because the good faith holder of the bill prevails over a previous holder that unfairly lost its possession Literality Literality means that the existence and content of the obligation is defined by the document. This is another dimension of incorporation of the credit in the bill. But it goes further to justify the protection of the good faith holder in terms that several defects of will cannot be opposed to him, thus making circulation easier. Abstraction Abstraction means that the causal or underlying business is separated from the bill of exchange. In fact, the defects of the causal or underlying transaction cannot be opposed to subsequent good faith holders of the bill. However, in case they are in bad faith those defenses can be opposed to them. Autonomy Autonomy means that exceptions of the causal transaction cannot be opposed to subsequent holders in good faith (appraised at the moment of acquisition of the bill, and that the legitimate holder of the bill has an autonomous right, and therefore a previous holder that unfairly lost its possession cannot oppose to the legitimate holder the illegitimacy of the prior holder of the bill who has transmitted the bill to him. In this context, gross negligence means bad faith, for example, in case the holder gets the bill from someone well known to be a thief or an indigent person.

04 Forfeiting Forfeiting and factoring are services in international market given to an exporter or seller. Its main objective is to provide smooth cash flow to the sellers. The basic difference between the forfeiting and factoring is that forfeiting is a long term receivables (over 90 days up to 5 years) while factoring is short termed receivables (within 90 days) and is more related to receivables against commodity sales. 11

Definition of Forfeiting The terms forfeiting is originated from a old French word ‘forfeit’, which means to surrender ones right on something to someone else. In international trade, forfeiting may be defined as the purchasing of an exporter’s receivables at a discount price by paying cash. By buying these receivables, the forfeiter frees the exporter from credit and the risk of not receiving the payment from the importer. 4.1 How forfeiting Works in International Trade The exporter and importer negotiate according to the proposed export sales contract. Then the exporter approaches the forfeiter to ascertain the terms of forfeiting. After collecting the details about the importer, and other necessary documents, forfeiter estimates

risk

involved

in

it

and

then

quotes

the

discount

rate.

The exporter then quotes a contract price to the overseas buyer by loading the discount rate and commitment fee on the sales price of the goods to be exported and sign a contract with the forfeiter. Export takes place against documents guaranteed by the importer’s bank and discounts the bill with the forfeiter and presents the same to the importer for payment on due date. 4.2 Documentary Requirements In case of Indian exporters availing forfeiting facility, the forfeiting transaction is to be reflected in the following documents associated with an export transaction in the manner suggested below: •

Invoice: Forfeiting discount, commitment fees, etc. needs not be shown separately instead, these could be built into the FOB price, stated on the invoice.

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Shipping Bill and GR form: Details of the forfeiting costs are to be included along with the other details, such FOB price, commission insurance, normally included in the "Analysis of Export Value "on the shipping bill. The claim for duty 12

drawback, if any is to be certified only with reference to the FOB value of the exports stated on the shipping bill. The forfeiting typically involves the following cost element

1. Commitment fee, payable by the exporter to the forfeiter ‘for latter’s’ commitment to execute a specific forfeiting transaction at a firm discount rate within a specified time.

2. Discount fee, interest payable by the exporter for the entire period of credit involved and deducted by the forfeiter from the amount paid to the exporter against

the

avulsed

promissory

notes

or

bills

of

exchange.

4.3 Benefits to Exporter  100 per cent financing: Without recourse and not occupying exporter's credit line That is to say once the exporter obtains the financed fund, he will be exempted from the responsibility to repay the debt.

 Improved cash flow: Receivables become current cash inflow and it is beneficial to the exporters to improve financial status and liquidation ability so as to heighten further the funds raising capability.

 Reduced administration cost: By using forfeiting, the exporter will spare from the management of the receivables. The relative costs, as a result, are reduced greatly.

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 Advance tax refund: Through forfeiting the exporter can make the verification of export and get tax refund in advance just after financing.  Risk reduction: forfeiting business enables the exporter to transfer vary risk resulted from deferred payments, such as interest rate risk, currency risk, credit risk, and political risk to the forfeiting bank.

 Increased trade opportunity: With forfeiting, the export is able to grant credit to his buyers freely, and thus, be more competitive in the market. 4.4 Problem areas in forfeiting  There is, presently, no legal framework to protect the banker or forfeiter except

the existing covers for the risks involved in any foreign transactions.  Data available on credit rating agencies or importer or foreign country is not

sufficient. Even exam bank does not cover high-risk countries like Nigeria.  High country and political risks dissuade the services of factoring and banking to many clients.  Government agencies and public sector undertakings (PSUs) neither promptly make payments nor pay interest on delayed payments.. The assignment of book debts attracts heavy stamp duty and this has to be waived.  Legislation is required to make assignment under factoring have priority over

other assignments.  There should be some provisions in law to exempt factoring organization from

the provisions of money lending legislations. 14

 The order 37 of Civil procedure code should be amended to clarify that factor

debts can be recovered by resorting to

05 Letters of Credit Letters of credit accomplish their purpose by substituting the credit of the bank for that of the customer, for the purpose of facilitating trade. There are basically two types: commercial and standby. The commercial letter of credit is the primary payment mechanism for a transaction, whereas the standby letter of credit is a secondary payment mechanism. Commercial Letter of Credit Commercial letters of credit have been used for centuries to facilitate payment in international trade. Their use will continue to increase as the global economy evolves. Letters of credit used in international transactions are governed by the International Chamber of Commerce Uniform Customs and Practice for Documentary Credits. The general provisions and definitions of the International Chamber of Commerce are binding on all parties. Domestic collections in the United States are governed by the Uniform Commercial Code. A commercial letter of credit is a contractual agreement between banks, known as the issuing bank, on behalf of one of its customers, authorizing another bank, known as the advising or confirming bank, to make payment to the beneficiary. The issuing bank, on the request of its customer, opens the letter of credit. The issuing bank makes a commitment to honor drawings made under the credit. The beneficiary is normally the provider of goods and/or services. Essentially, the issuing bank replaces the bank's customer as the payee. 5.1 Elements of a Letter of Credit 15

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A payment undertaking given by a bank (issuing bank)

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On behalf of a buyer (applicant)

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To pay a seller (beneficiary) for a given amount of money

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On presentation of specified documents representing the supply of goods

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Within specified time limits

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Documents must conform to terms and conditions set out in the letter of credit

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Documents to be presented at a specified place

Beneficiary The beneficiary is entitled to payment as long as he can provide the documentary evidence required by the letter of credit. The letter of credit is a distinct and separate transaction from the contract on which it is based. All parties deal in documents and not in goods. Issuing Bank The issuing bank's liability to pay and to be reimbursed from its customer becomes absolute upon the completion of the terms and conditions of the letter of credit. The issuing banks' role is to provide a guarantee to the seller that if compliant documents are presented, the bank will pay the seller the amount due and to examine the documents, and only pay if these documents comply with the terms and conditions set out in the letter of credit. Advising Bank An advising bank, usually a foreign correspondent bank of the issuing bank will advise the beneficiary. Generally, the beneficiary would want to use a local bank to insure that the letter of credit is valid. In addition, the advising bank would be responsible for sending the documents to the issuing bank. The advising bank has no other obligation under the letter of credit. If the issuing bank does not pay the beneficiary, the advising bank is not obligated to pay. Confirming Bank The correspondent bank may confirm the letter of credit for the beneficiary. At the 16

request of the issuing bank, the correspondent obligates itself to insure payment under the letter of credit. The confirming bank would not confirm the credit until it evaluated the country and bank where the letter of credit originates. The confirming bank is usually the advising bank.

06 Factoring In finance factoring, a business will sell off its accounts receivable, which are the invoices that the company has coming in, at a discounted rate. By doing this, the organization or business is able to obtain cash, or capital, that is readily available to them rather than waiting for the accounts receivable to actually come in to them. In many situations, this helps to keep the organization afloat and helps them to pay debts they may have. There are several differences between finance factoring and a business loan that may be obtained from a bank, for example. First, when considering this type of finance, the value of the receivables is the ultimate important number. This is in contrast to the credit worthiness of the business, which is what would happen in a business loan. Secondly, another area the two differ is that the factoring does not offer a loan to the business. Rather, it is more of a purchase of an asset that the business has. There is a third way in which finance factoring is different from a business loan. That is the structure of it. Whereas with a business loan involves just two parties, the bank and the borrower, the factoring system involves three parties. This includes the receivable clients, the business owner and the company that purchases the receivables In finance factoring, the business will sell their receivables to a third party who pays the business a fraction of what those receivables are worth. The customers of the business then pay the receivables to the third party at full price. In this transaction, any defaulting on the behalf of the receivables is not dealt with by the business any longer. There are many situations in which finance factoring becomes an important part of the business and therefore is used often. 17

6.1 How factoring can benefit your business •

Factoring is competitively priced compared to overdrafts and business loans

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You have more working capital to put back into your business

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The facility grows with your business so there is no need to keep increasing your overdraft or take out additional loans

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You’ll know when you’ll be paid, which helps you manage your cash flow

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You can react more quickly to market opportunities

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The Factor can manage your sales ledger and protect you from bad debts

6.2 What are the main features of Factoring? •

Up to 90% of the value of your invoices can be advanced by the next working day

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Flexible finance – Factor some or all of your sales ledger

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The Factoring company can take over management of your sales ledger

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The facility is easy to set up through Simply Business

07 International financial markets In economics, typically, the term market means the aggregate of possible buyers and sellers of a thing and the transactions between them. The term "market" is sometimes used for what are more strictly exchanges, organizations that facilitate the trade in financial securities, e.g., a stock exchange or commodity exchange. This may be a physical location or an electronic system. Much trading of stocks takes place on an exchange; still, corporate actions (merger, spinoff) are outside an exchange, while any two companies or people, for whatever reason, may agree to sell stock from the one to the other without using an exchange. Trading of currencies and bonds is largely on a bilateral basis, although some bonds trade on a stock exchange, and people are building electronic systems for these as well, similar to stock exchanges. Financial markets can be domestic or they can be international. 18

7.1 Types of financial markets The financial markets can be divided into different subtypes: •

Capital markets which consist of: o

Stock markets, which provide financing through the issuance of shares or common stock, and enable the subsequent trading thereof.

o

Bond markets, which provide financing through the issuance of bonds, and enable the subsequent trading thereof.

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Commodity markets, which facilitate the trading of commodities.

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Money markets, which provide short term debt financing and investment.

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Derivatives markets, which provide instruments for the management of financial risk. o

Futures markets, which provide standardized forward contracts for trading products at some future date; see also forward market.

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Insurance markets, which facilitate the redistribution of various risks.

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Foreign exchange markets, which facilitate the trading of foreign exchange.

The capital markets consist of primary markets and secondary markets. Newly formed (issued) securities are bought or sold in primary markets. Secondary markets allow investors to sell securities that they hold or buy existing securities. 7.2 What is their purpose? Without financial markets, borrowers would have difficulty finding lenders themselves. Intermediaries such as banks help in this process. Banks take deposits from those who have money to save. They can then lend money from this pool of deposited money to those who seek to borrow. Banks popularly lend money in the form of loans and mortgages. 19

More complex transactions than a simple bank deposit require markets where lenders and their agents can meet borrowers and their agents, and where existing borrowing or lending commitments can be sold on to other parties. A good example of a financial market is a stock exchange. A company can raise money by selling shares to investors and its existing shares can be bought or sold. 7.3 Financial market participants There are four main participants 1. The Central Bank The Central Bank is the federal government's bank and has the following roles in the financial market: a) is the lender of last resort? b) Oversees and conducts monetary policy. c) Preserves the value of the dollar. 2. Deposit Intermediaries Deposit intermediaries include the following institutions: a) Banks b) Credit Unions c) Mortgage and loan companies. d) Mortgage and loan agencies. 3. Contractual savings intermediaries Contractual savings intermediaries are in the form of the following: a) Life insurance companies. b) Pension funds. c) Property and casualty insurance companies d) Government pension plans.

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4. Investment intermediaries Investment intermediaries include: a) Mutual funds companies, b) Investment dealers. c) Consumer loan companies. d) Business finance companies.

08 What is Foreign Direct Investment (FDI) According to the IMF and OECD definitions, direct investment reflects the aim of obtaining a lasting interest by a resident entity of one economy (direct investor) in an enterprise that is resident in another economy (the direct investment enterprise). The “lasting interest” implies the existence of a long-term relationship between the direct investor and the direct investment enterprise and a significant degree of influence on the management of the latter. Direct investment involves both the initial transaction establishing the relationship between the investor and the enterprise and all subsequent capital transactions between them and among affiliated enterprises, both incorporated and unincorporated. It should be noted that capital transactions which do not give rise to any settlement. The fifth Edition of the IMF’s Balance of Payment Manual defines the owner of 10% or more of a company’s capital as a direct investor. But the IMF recommends using this percentage as the basic dividing line between direct investment and portfolio investment in the form of shareholdings. Thus, when a non-resident who previously had no equity in a resident enterprise purchases 10% or more of the shares of that enterprise from a resident, the price of equity holdings acquired should be recorded as direct investment. From this moment, any further capital transactions between these two companies should be recorded as a direct investment. When a non-resident holds less than 10% of the shares of an enterprise as portfolio investment, and subsequently acquires additional shares

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resulting in a direct investment (10% of more), only the purchase of additional shares is recorded as direct investment in the Balance of Payments. 8.1 The case for free capital flows Economists tend to favor the free flow of capital across national borders because it allows capital to seek out the highest rate of return. Unrestricted capital flows may also offer several other advantages, as noted by Feldstein (2000). First, international flows of capital reduce the risk faced by owners of capital by allowing them to diversify their lending and investment. Second, the global integration of capital markets can contribute to the spread of best practices in corporate governance, accounting rules, and legal traditions. Third, the global mobility of capital limits the ability of governments to pursue bad policies. In addition to these advantages, which in principle apply to all kinds of private capital inflows? •

FDI allows the transfer of technology—particularly in the form of new varieties of capital inputs—that cannot be achieved through financial investments or trade in goods and services. FDI can also promote competition in the domestic input market.

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Recipients of FDI often gain employee training in the course of operating the new businesses, which contributes to human capital development in the host country.

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Profits generated by FDI contribute to corporate tax revenues in the host country.

Of course, countries often choose to forgo some of this revenue when they cut corporate tax rates in an attempt to attract FDI from other locations. For instance, the sharp decline in corporate tax revenues in some of the member countries of the Organization for Economic Cooperation and Development (OECD) may be the result of such competition.

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Conclusion The global financial system (GFS) is a financial system consisting of institutions and regulations that act on the international level, as opposed to those that act on a national or regional level. Foreign exchange market and management of exchange rate of a country’s currency are two key areas that influence the economic well-being of the general public. The exchange rate of a country’s currency is the value of its money for international trade in goods, services and finance and, therefore, it is part and parcel of the monetary condition of a country. Central banks, private banks, hedge funds, Investment management firms, Retail foreign exchange brokers are participate for foreign management. Dollars, Euro, Swiss frank, yen, pounds are the main currencies exchange in foreign exchange market. The most common and yet most complex form of negotiable instrument used for business transactions is known as the draft, or the bill of exchange. A bill of exchange can be used for payment, credit, or security in a financial transaction. Forfeiting and factoring are services in international market given to an exporter or seller. Its main objective is to provide smooth cash flow to the sellers. Letters of credit accomplish their purpose by substituting the credit of the bank for that of the customer, for the purpose of facilitating trade. International financial market is the world largest market in the world. It include bond market, stock market, capital market, derivatives markets, futures markets, insurance markets and foreign exchange market. According to the IMF and OECD definitions, direct investment reflects the aim of obtaining a lasting interest by a resident entity of one economy (direct investor) in an enterprise that is resident in another economy (the direct investment enterprise). The “lasting interest” implies the existence of a long-term relationship between the direct investor and the direct investment enterprise and a significant degree of influence on the management of the latter. 23

References

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Sunderam A.K, Black J.S, 1997, The International Business Environment, Pretice hall of india, New Delhi.

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Keeth Monk, Go international, Mc grae hill

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Thakur D, Mishra SK, 1989, International Business, Deep and Deep publications, New Delhi, India.

Website

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http://www.google.lk/search? hl=en&safe=strict&q=strategies+for+foreign+direct+investment&btnG=Search& meta=

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http://en.wikipedia.org/wiki/Global_financial_system

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http://www.cbsl.gov.lk/pics_n_docs/11_education/_docs/Articles_How_Centralba nks%20manage%20exchange%20rates.pdf

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