International Settlements PDF

# International Settlements ## Prezentacja 1 ### Settlements of Payments in International Trade * **Immediate vs. Deferred Payments** - Payment can be made instantly or at a later date. * **Cash vs. Cashless Payments** - Transactions can involve physical money or electronic transfers. * **Condit...

# International Settlements ## Prezentacja 1 ### Settlements of Payments in International Trade * **Immediate vs. Deferred Payments** - Payment can be made instantly or at a later date. * **Cash vs. Cashless Payments** - Transactions can involve physical money or electronic transfers. * **Conditional vs. Unconditional Payments** - Payment may depend on meeting specific conditions or be made without restrictions. * **Risk Management** - Managing financial risks arising from international payments. ## Foreign Exchange (FX) Market * The market where currencies are traded, operating 24/7. * **Main FX centers:** London, New York, Singapore, Hong Kong, Tokyo, Zurich, Frankfurt, Paris, Sydney. ## Functions of the FX Market ### Macroeconomic Functions: * Enables price comparisons of goods and financial instruments globally. * Supports international trade and monetary policy. * Connects local financial markets with international markets. ### Microeconomic Functions: * Provides foreign currency for businesses and individuals. * Offers hedging and speculation tools to manage risks. ## Daily foreign exchange turnover | Country | Turnover (bn USD) 2016 | Turnover (bn USD) 2019 | Turnover (bn USD) 2022 | Market Share (%) 2016 | Market Share (%) 2019 | Market Share (%) 2022 | |---|---|---|---|---|---|---| | UK | 2 406 | 3 576 | 3.755 | 36.9 | 43.1 | 38.1 | | USA | 1 272 | 1 370 | 1912 | 19.5 | 16.5 | 19.4 | | Singapore | 517 | 640 | 929 | 7.9 | 7.7 | 9.4 | | Hong Kong | 437 | 632 | 694 | 6.7 | 7.6 | 7.1 | | Japan | 399 | 376 | 433 | 6.1 | 4.5 | 4.4 | ## The most widely traded currencies (%) * USD - 88.4 * EUR - 30.5 * JPY - 16.7 * GBP - 12.7 * PLN - 0.7 ## The most important currency pairs (%) * EUR/USD - 22,7 * USD/JPY - 13,5 * GBP/USD - 9,5 The exchange rate is the price of one currency in exchange for another. * 1 USD = 3.8320 PLN * USD / PLN = 3.8320 * 3.8320PLN / USD **USD** - base currency (the first currency quoted in a currency pair) **PLN** - quote currency (the second currency quoted in a currency pair) ## Base and quote currencies Priority with regard to base currency: EUR, GBP, AUD, NZD, FJD (Fijian dollar), TOP (pa’anga – Tonga), WST (tala – Samoa), PGK (kina – Papua New Guinea), BWP (pula – Botswana), SBD (Solomon Islands dollar), USD * **Direct quotes** - foreign currency is the base currency * **Indirect quotes** - foreign currency is the quote currency From a Frenchman's point of view, which of each pair of quotes is the direct quote? Which is the indirect quote? a) EUR/GBP = 0.8975, GBP/EUR= 1.1142 b) USD/EUR = 0.7854, EUR/USD= 1.2732 c) EUR/PLN = 4.3000, PLN/EUR= 0.2326 From a Frenchman's point of view (EUR is the home currency): a) **Direct quote:** GBP/EUR = 1.1142 **Indirect quote:** EUR/GBP = 0.8975 b) **Direct quote:** USD/EUR = 0.7854 **Indirect quote:** EUR/USD = 1.2732 c) **Direct quote:** PLN/EUR = 0.2326 **Indirect quote:** EUR/PLN = 4.3000 ## Why? * A direct quote expresses how much home currency (EUR) is needed for 1 unit of foreign currency (e.g., GBP/EUR, USD/EUR, PLN/EUR). * An indirect quote expresses how much foreign currency is needed for 1 unit of home currency (EUR) (e.g., EUR/GBP, EUR/USD, EUR/PLN). ## The concept of BID and OFFER/ASK EUR / PLN = 4.8945 – 4.8990 **BID** **OFFER/ASK** ## Difference between OFFER and BID – SPREAD ## ISO Codes * ISK – Icelandic Króna * CZK - Czech Koruna * HKD - Hong Kong Dollar * DOP - Dominican Peso * EGP - Egyptian Pound * IDR - Indonesian Rupiah * NAD - Namibian Dollar * TND – Tunisian Dinar * ZAR - South African Rand * VND - Vietnamese Dong ## Currency pairs represented by these slang names: * **Cable** → GBP/USD (British Pound / US Dollar) * **Fiber** → EUR/USD (Euro / US Dollar) * **Aussie** → AUD/USD (Australian Dollar / US Dollar) * **Kiwi** → NZD/USD (New Zealand Dollar / US Dollar) * **Swissy** → USD/CHF (US Dollar / Swiss Franc) * **Stockey / Stokkie** → USD/SEK (US Dollar / Swedish Krona) * **Copey / Coppie** → USD/DKK (US Dollar / Danish Krone) * **Oslo / Nokkie** → USD/NOK (US Dollar / Norwegian Krone) * **Bill & Ben** → EUR/GBP (Euro / British Pound) * **Loonie** → USD/CAD (US Dollar / Canadian Dollar) ## Spot Transactions * The simplest FX transactions, where currencies are exchanged within two working days. ## Foreign Exchange Risk (Currency Risk) * The risk that exchange rate fluctuations will impact business operations. ## Foreign Exchange Position * The balance of receivables and liabilities in a foreign currency. ## Managing FX Risk ### Internal Techniques: * **Invoicing in local currency** - Transfers risk to the trading partner. * **Invoicing in a third-country currency** - Payments settled in a neutral currency. * **Netting** – Offsetting receivables and payables in the same currency. * **Leading and Lagging** - Adjusting payment timing based on FX rate trends. ### External Techniques (Derivatives): * **Forward** - Agreement to buy/sell currency at a fixed future date and rate. * **FX Swap** - Simultaneous purchase and sale of currency for different dates. * **Futures & Options** - Traded on regulated exchanges, allowing hedging against FX fluctuations. ## Forward Rate & Interest Rate Relationship * The forward rate depends on spot rate and interest rates of the two currencies. * A currency with a higher interest rate has a forward discount, while a currency with a lower interest rate has a forward premium. * Forward points (swap points) reflect the difference between the forward rate and spot rate and indicate which currency has a higher interest rate. To determine which currency has a higher interest rate, we analyze the forward points. **Key Concept**: * Forward points represent the difference between the spot rate and the forward rate. * If forward points are positive (added to the spot rate), the base currency (GBP) has a higher interest rate than the quote currency (USD). * If forward points are negative (subtracted from the spot rate), the quote currency (USD) has a higher interest rate than the base currency (GBP). **Given Data**: * Spot GBP/USD = 1.2500 – 1.2600 * Forward points = 80 – 90 (which are positive) Since the forward points are positive, it means that the forward rate is higher than the spot rate. This indicates that GBP has a higher interest rate than USD. **Final Answer**: GBP has a higher interest rate than USD. To determine whether the 2-month forward rate is higher or lower than the spot rate, we analyze the interest rate differential: **Key Rule**: * If the base currency (SEK) has a lower interest rate than the quote currency (PLN), the forward rate will be higher than the spot rate. * If the base currency (SEK) has a higher interest rate than the quote currency (PLN), the forward rate will be lower than the spot rate. **Given Data**: * Spot rate SEK/PLN = 0.3800 * 2-month interest rate in PLN = 4% (0.04) * 2-month interest rate in SEK = 2% (0.02) Since PLN has a higher interest rate than SEK, the forward rate will be higher than the spot rate. **Final Answer**: The 2-month forward rate will be higher than the spot rate. **Non-deliverable forward (NDF)**-> NDF is a forward transaction where physical delivery does not take place. ## Hedging Strategy Explanation: Company XYZ is expecting to receive 100,000 EUR in PLN in 4 months but is concerned about currency risk. If the EUR/PLN exchange rate drops, the company will receive fewer PLN than expected. To protect against this risk, the company enters into a Non-Deliverable Forward (NDF) contract at a forward rate of 4.5000. This means that after 4 months, regardless of the actual exchange rate, the company will settle the difference between the contracted forward rate and the reference rate (NBP rate of 4.4050) in cash. ## Settlement of the NDF Contract: 1. Contracted Forward Rate: 4.5000 (EUR/PLN) 2. Reference Rate (NBP Average Rate after 4 months): 4.4050 3. Notional Amount: 100,000 EUR ## Final Outcome: * Since the forward rate (4.5000) is higher than the reference rate (4.4050), the company gains 9,500 PLN from the NDF contract. * However, the company still receives PLN at the actual spot rate of 4.3800 for its 100,000 EUR invoice. * The NDF payout offsets the currency loss, ensuring better financial stability ## Conclusion: By using an NDF, Company XYZ successfully hedged against a drop in EUR/PLN. Although the actual spot rate was even lower (4.3800), the NDF ensured that the company recovered 9,500 PLN, reducing its overall foreign exchange risk. ## FX SWAP FX SWAP is the simultaneous sale and purchase of a certain amount of foreign currency for two different dates. Swaps usually involve spot transactions against forward transactions, or forward transactions against forward transactions ### Application of fx swaps * Maintaining liquidity * Rolling over and rolling back the forward transactions ## Currency Futures - Simplified Explanation A currency futures contract is an agreement between two parties to buy or sell a specific amount of currency at a fixed price on a future date. These contracts are traded on regulated exchanges and follow strict standardization. ### Key Features of Currency Futures: * Traded on a central exchange, ensuring transparency and regulation. * Highly standardized, meaning each contract specifies the currency pair, contract size, and settlement date. * Actual delivery of currency is rare—most contracts (over 95%) are closed before settlement through buying or selling an opposite position. * Clearing houses guarantee transactions, reducing the risk of default. * Traders must provide an initial margin (a deposit) and maintain a required margin level, as profits and losses are settled daily based on market movements. This system ensures that currency futures remain a secure and structured way to manage foreign exchange risk or speculate on currency price changes. * the futures market is much smaller market than the forward ## CURRENCY OPTION CURRENCY OPTION is a contract which gives the buyer the right, but not the obligation, to buy or sell a fixed amount of foreign currency, at a fixed price (strike price, exercise price) at a fixed time in the future. Buying an option involves an up-front cost called “premium” which is received by the option writer. There are no other commissions involved in the transaction. ## Call option * The graph shows the financial situation of the call option buyer and writer. * The X-axis represents the rate of exchange. * The Y-axis represents the profit/loss the buyer and writer will make. ## Put option * The graph shows the financial situation of the Put option buyer and writer. * The X-axis represents the rate of exchange. * The Y-axis represents the profit/loss the buyer and writer will make. ## Long Straddle strike price: 4,2700; premia dla obu opcji: 0,0680 ## Types of Options - Quick Summary * **Call Option** – Gives the buyer the right to buy a currency at a fixed price before or on the expiration date. * **Put Option** – Gives the buyer the right to sell a currency at a fixed price before or on the expiration date. * **European Style Option** – Can only be exercised on the expiration date (not before). * **American Style Option** – Can be exercised at any time before or on the expiration date. * **In the Money (ITM)** – An option that has intrinsic value (profitable if exercised immediately). * **At the Money (ATM)** – The strike price equals the current market price, meaning no profit or loss if exercised. * **Out of the Money (OTM)** – An option that has no intrinsic value (not profitable to exercise at the moment). ## Elements of premium * Intrinsic value * Extrinsic value (time value) Premium = intrinsic value + time value # Prezentacja 2 # Main Law Systems for Bills of Exchange (B/E) and Promissory Notes (P/N): ## 1. Conventional (Genevan) System: * Based on Geneva Conventions (1930), covering uniform laws, conflict resolution, and stamp laws for B/E and P/N. * Followed by countries like Austria, Poland, Japan, Russia, and Turkey. ## 2. Anglo-Saxon System: * Governed by the Bills of Exchange Act 1882 (UK) and the Uniform Commercial Code 1952 (USA). * Includes the Electronic Trade Documents Act 2023 (UK). * Used in USA, UK, Canada, Australia, and Singapore. ## 3. UNCITRAL Convention (1988): * Aims for a unified global framework but not widely ratified. # Polish Law: * Act on Bills of Exchange and Promissory Notes, 28 April 1936. ## Promissory note (P/N) * a document in writing, containing an unconditional promise, signed by the person making the note, to pay a certain sum of money to the order of a certain named person (the payee) at a specified date in the future * the issuer of the P/N is the one obliged to pay * in international trade, the writer of the promissory note is the importer, who is obliged to pay for goods or services ## Bill of exchange (B/E) * An unconditional order in writing addressed by one person (the drawer) to another (the drawee) signed by the person giving it, requiring (ordering) the person to whom it is addressed to pay on demand or at a fixed future date a sum certain in money to the order of a specified person (the payee) * In international trade the drawer is exporter, who requires the importer (the drawee) to pay for goods or service to the order of exporter * in B/E drawn by exporter to the importer, the payee ant the drawer is the same person * the drawee becomes obliged to pay after having accepted the B/E which is done by their signature at the front of B/E * after having accepted the B/E, the drawee becomes an acceptant ## Maturity dates of B/E, P/N * At sight * Some time after sight (e.g. at 7 days after sight) * Some time afer issuance date (e. g. at 3 months after date) * On the specific day (e.g. on 25th January 2025) CANT BE “after my death” or anuthuing like that since it has an uncertain due date and it violates the requirement for a fixed payment date under most legal frameworks. # Transfer of Rights in a Bill of Exchange (B/E) or Promissory Note (P/N) ## 1. Endorsement (Transfer by Signature) * If a B/E or P/N is written “to the order of”, it can be transferred to another person through endorsement. * Endorser: The person who transfers the rights by signing the instrument (usually the payee). The first payee who endorses it becomes the first endorser. * Endorsee: The person receiving the endorsed B/E or P/N. The endorsee can further endorse it to another person, becoming an endorser themselves. * How it's done: The endorser signs the back of the document, parallel to its shorter side. ## 2. Guarantee (Per Aval - Additional Payment Assurance) * A guarantor ensures full or partial payment of the B/E or P/N. * To provide a guarantee, the guarantor writes "Per aval for [name]" on the front side of the document and signs it. * Example: Guarantor: Barclays Bank, London Per aval for Machines Ltd /Signatures/ This process allows secure transfer and added assurance of payment. ## P/N & B/E can serve as * an instrument of payment * a collateral * as an instrument of finance ## Forms of payment in international trade * open account * documentary collection * letter of credit * advance payment ## Documentary collection Bank collection is an operation in which the exporter entrusts the collection of payment to the exporter's bank (remitting bank), which sends documents to the importer's bank (collecting bank), along with instructions for payment. ## Types of Documentary Collection * **D/P (Documents Against Payment) Collection** - The buyer receives the shipping documents only after making full payment to the bank. * **D/A (Documents Against Acceptance) Collection** – The buyer receives the shipping documents after accepting a bill of exchange, agreeing to pay at a later date. ## Documents used in documentary collection: * bill of exchange * commercial invoice * specifications and separate packing or weight lists * relevant transport documents * certificate of origin * inspection certificates, veryfying quality or quantity of the goods * insurance documents * other certificates such as test or performance certificates # Advantages and Disadvantages of Documentary Collection ## Advantages for the Exporter: * The importer cannot access shipping documents (and therefore the goods) until they make payment. * Bills of Exchange (B/E) can be used as collateral, providing financial security. * The exporter can improve liquidity by discounting or selling the B/E before maturity. ## Advantages for the Importer: * Ensures that the goods have been shipped before payment is required. * The importer controls the payment decision, unlike in letters of credit. * With D/A (Documents Against Acceptance), the importer can delay payment (trade credit). * If there is an error in the documents, the importer can delay payment until the issue is resolved. ## Disadvantages for the Exporter: * The importer can refuse to accept the documents, leading to non-payment. * Payment may be delayed or denied due to political or economic issues in the importer's country. * If there is an error in the documents, the importer can use it as a reason to delay payment. ## Disadvantages for the Importer: * The importer cannot inspect the goods before making payment. * If the importer refuses to accept the B/E, it could damage their reputation with banks and suppliers. This system provides more security than open account trading but is less secure than a letter of credit for the exporter. # International Rules for Documentary Collection * **URC 522 (Uniform Rules for Collection)** – Issued by the ICC (International Chamber of Commerce) in 1996, providing standardized rules for banks and customers to facilitate documentary collection. * **eURC 1.0 (2019)** – A supplement for electronic presentation of documents. * **URC 522** covers: Standard definitions, obligations, responsibilities, document presentation, payment, acceptance, and protesting bills of exchange. ## A documentary credit * An obligation undertaken by bank to make the payment to the exporter immediately or at agreed future time, after terms of L/C (Letter of Credit) have been fulfilled by the exporter (required documents have been presented) In the case of letter of credit decision about the payment is made by the bank !!!!! ## The parties to a documentary credit * The applicant for the credit (importer) * The issuing bank (importer's bank) * The beneficiary (exporter) * The advising bank (exporter's bank) ## Strict compliance * The documents have to comply strictly with the terms of L/C (the documents must conform very precisely with the terms of the credit) * A presentation of documents that is in accordance with terms and conditions of the credit and applicable rules is called a complying presentation ## Example of documents required in L/C 46A: Documents Required 1. SIGNED COMMERCIAL INVOICE IN SIX COPIES ORIGINAL MUST BE CERTIFIED BY CHAMBER OF COMMERCE AND LEGALIZED BY YEMEN OR ANY ARAB EMBASSY OR CONSULATE. 2. FULL SET OF 3/3 SHIPPED ON BOARD''OCEAN BILL OF LADING MADE OUT TO THE ORDER OF YEMEN KUWAIT BANK MARKED FREIGHT PREPAID AND NOTIFYING BUYERS. 3. CERTIFICATE OF ORIGIN IN DUPLICATE ORIGNAL CERTIFIED BY CHAMBER OF COMMERCE AND LEGALIZED BY YEMEN EMBASSY OR ANY ARAB EMBASSY OR CONSULATE STATING THAT THE GOODS ARE OF POLAND ORIGIN, 4. CERTIFICATE OF WEIGHT AND PACKING LIST IN FIVE COPIES 5. SHIPPING COMPANY CERTIFICATE STATING THAT THE CARRYNIG VESSEL BELONGS TO REGULAR LINE, IS NOT MORE THAN 25 YEARS OLD. CLASSIFIED AS LLOYDS 100 A1-OR EQUIVALENT A CERTIFICATE TO THIS EFFECT TO BE PRESENTED WITH L/C DOCUMENTS UPON NEGOTIATION. 6. HEALTH CERTIFICATE STATING GOODS ARE FIT FOR HUMAN CONSUMPTION ## Types of Letters of Credit (L/C) * **Revocable L/C** – Can be amended or canceled anytime by the issuing bank. Rarely used due to low security. (Note: Under UCP 600, all L/Cs are irrevocable by default.) * **Irrevocable L/C** – Once issued, the bank must honor the payment if the beneficiary meets all conditions. Cannot be changed or canceled without consent from both the importer and exporter. * **Unconfirmed L/C** – Only the issuing bank guarantees payment; the advising bank does not take any risk. * **Confirmed L/C** – The advising bank adds its guarantee to pay the exporter. If documents comply with the L/C terms, the advising bank will process the payment. ## Methods of Payment Under L/C: * **Payment at Sight L/C** – Payment is made immediately once the required documents are presented. * **Deferred Payment L/C** – Payment is made at a later date, as agreed in the contract. # Benefits and Disadvantages of Letters of Credit (L/C) ## Benefits ### For the Exporter: * Guarantees payment if the required documents are correctly presented. * Protects against the importer's refusal to pay or financial insolvency. * Can be used as collateral for a bank loan, helping finance production. ### For the Importer: * Payment is made only if the exporter meets all L/C conditions. * No payment is required if the shipment has not been made. * Reduces the risk of receiving defective products if a certificate of quality from an independent institution is required. ## Disadvantages ### For the Exporter: * Time-consuming, requiring careful verification and collection of necessary documents. * An unconfirmed L/C does not protect against political risk. ### For the Importer: * No absolute guarantee that the exporter will fully perform the contract. * Funds may be tied up even before shipment. * Once the required documents comply with the L/C, payment must be made, regardless of potential disputes. * High costs and complex procedures. # International Rules for Documentary Credit * **UCP 600 (Uniform Customs and Practice for Documentary Credits)** - Issued by the ICC on July 1, 2007, providing standardized rules for banks and customers in letter of credit transactions. * **eUCP 2.0 (2019)** – A supplement for electronic document presentation. * **UCP 600** aims to reduce document discrepancies, as surveys in 2003 showed that around 70% of first-time presentations were rejected by banks. ## Forms of international trade payments from the perspective of exporter and importer | Payment method | Importer purchasing power | Credit risk to exporter | |---|---|---| | Open account | High |High | | D/A collection | High |High | | D/P collection | High | High | | Letter of credit | Low | Low | | Cash in advance | Low | Low | # Problems Faced by Exporters Selling on Open Account Terms & Solutions ## Liquidity Risk The exporter may face cash flow shortages if the buyer delays payment. * **Bank Loans** - Provides immediate working capital while waiting for payment. ## Credit Risk The buyer may fail to pay due to insolvency or refusal. * **Credit Insurance** - Protects against non-payment by covering potential financial losses. ## Currency Risk Exchange rate fluctuations can reduce the value of received payments in foreign currency. * **Derivatives** – Tools like forwards and options help lock in exchange rates and prevent losses. ## Other Methods Alternative financing methods can help exporters secure payments and reduce risks. * **Factoring, forfaiting, or letters of credit** – Ensure faster access to funds and reduce default risks. # Factoring - Key Points ## Definition: Factoring is an agreement where a factoring company (factor) buys a business's accounts receivable for immediate cash and manages debt collection. ## Services Provided by the Factor: * Maintains ledgers and bookkeeping. * Collects outstanding accounts receivable. * Assumes credit risk, meaning the factor takes responsibility if the debtor fails to pay. ## Main Functions of Factoring: * **Financing** - Provides immediate liquidity by converting receivables into cash. * **Debt administration and collection** - Manages invoice processing and collections. * **Payment guarantee** - Protects businesses from customer defaults. ## Full-Service Factoring: When the factor performs all these functions, it is called full-service factoring. # Relations between factoring company and its client ## Types of Factoring * **Domestic Factoring** - The seller assigns receivables from domestic sales to a factor within the same country. * **International Factoring (Cross-Border Factoring)** - The seller assigns receivables from export sales to a factor. ## Types of International Factoring: * **Indirect Factoring (Two-Factor System)** - Involves two factors: one in the exporter's country and one in the importer's country, ensuring better risk management. * **Direct Factoring** - Managed by one factor only, either in the exporter's country (direct export factoring) or the importer's country (direct import factoring). ## Two Factors System * **FCI** * Founded in 1968 (in January 2016 merged with IFG) * Headquarters in Amsterdam * 400 members from over 90 countries (data on 2024) ## Direct Export Factoring ## Direct Import Factoring ## Entities Offering Factoring * **Banks** – Some banks provide factoring services directly (e.g., BOŚ Bank, Bank Millennium). * **Banks' Subsidiaries** – Factoring companies owned by banks, specializing in financing receivables (e.g., ING Commercial Finance, Pekao Faktoring). * **Independent Factors** – Non-bank financial institutions that focus only on factoring (e.g., Coface Poland Faktoring, PragmaGO, SMEO). # Benefits of Factoring for the Exporter * **Higher sales** – Allows exporters to offer better payment terms to customers. * **Protection against bad debts** – The factor takes on the risk of non-payment. * **Better cash flow** – The exporter gets money faster instead of waiting for customers to pay. * **Less administration work** – The factor handles sales ledgers and debt collection. * **Lower administrative costs** – Saves money on managing accounts and chasing payments. * **Stronger balance sheet** – Factoring improves liquidity by turning receivables into cash. * **Reduced currency risk** – Some factoring services protect against exchange rate changes. * **Early payment discounts** – Exporters can settle debts earlier and negotiate better prices. * **Easier access to funds** – Factoring is widely available, even for smaller businesses. # Disadvantages of Factoring for the Exporter * **Higher costs** compared to other financing methods, including: * Factoring fees for services and risk coverage. * Interest charges on prepayments made by the factor. * **Political risk is not covered**, meaning losses due to political instability remain the exporter's responsibility. * **Restrictions on certain countries** - Some export receivables may not qualify for factoring due to risk concerns.