International transactions in cash require two distinct purchases

Purchase of foreign currency Purchase of good/service with the FC

The term Foreign Exchange is used to denote:

a foreign currency - ie. currency of another country the exchange of one currency into another.

As per FEMA 1999, Foreign exchange includes:

Deposits, credits and balances payable in foreign currency Drafts, travelers' cheques, letter of credit or bill of exchange expressed or drawn in Indian currency but payable in foreign country. Drafts, travelers' cheques, L/Cs, etc. drawn by banks, institutions or persons outside India but payable in Indian currency abroad.
2

This market exists to cater to the demand for foreign currency. Currency is needed around the world for international trade and investments. The largest financial market in the world, trading around $1.5 trillion each day. Dynamic high fluctuations in rates. round the clock market. No central location. Over the counter market. Trading between participants through electronic communication networks (ECNs) and phone networks Settlements affected through time zone factor.
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Tokyo

New York

London

Zurich

Frankfurt

Central Banks

Foreign Exchange dealers

to manage their reserves and the value of their home currency.

Investment Funds/Banks

for their retail clients hedging and investing their own assets and liabilities.
moving funds from one country to another investments in various countries. and hedging their

Forex brokers

Corporations

middlemen between other participants and at times taking positions on their books.

Individuals

moving funds between different counties and currencies for investment or trade transaction. ordinary or high net worth individuals for investment, trade, persona needs etc.
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Spot Exchange Rate:

Forward Exchange Rate:

represent the price that a buyer expects to pay for a foreign currency in another currency. Settlement in case of spot rate is normally done within one or two working days. rate that is quoted and traded today but for delivery and payment on a specific future date. Direct Quotation:

There are two methods of quoting exchange rates:

Indirect Quotation:

variable units of home currency equivalent to a fixed unit of foreign currency are quoted. (US$ 1= Rs. 46.8143) variable units of foreign currency as equivalent to a fixed unit of home currency (US $ 2.1361= Rs.100)

After 1993 banks are quoting rates on direct basis only.

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A contract between two parties (the Bank and the customer). to sell or buy one currency for another, at an agreed future date, at a rate of exchange which is fixed at the time the contract is entered into. Foreign Currency Options

Flexible Forwards

gives the owner the right to buy or sell the indicated amount of foreign currency at a specified price before a specific date. The buyer of option has the right but no obligation to enter into a contract with the seller. Therefore the buyer of a currency option has the right, to his advantage, to enter into the specified contract. an alternative to forward exchange contracts and currency options. The agreement to exchange a specified amount of one currency for another currency at a foreign exchange rate that is determined in accordance with the mechanisms set out in the agreement at an agreed time and an agreed date (the expiry time on the expiry date). also known as cross currency swap is a foreign exchange agreement between two countries to exchange a given amount of one currency for another and, after a specified period of time, to give back the original amounts swapped.
8

Currency Swap

Generally, the Forex rates quoted are spot rates. Forward rate = Spot rate + Premium (- discount) If the forward rate is higher than the spot rate, the currency is at a premium and if lower, it is discount. Bid and offered rates:

In USD/INR 46.80/81 the bank is bidding for USD at Rs. 46.80 and offering to sell USD at Rs. 46.81

Cross rates:

To obtain rates for a particular currency pair when they are not available directly 1 US $ = Rs. 46.8125 = 3.7563 Saudi Riyal 1SAR = 46.8125/3.7563 = 12.4625
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The bid rate always precedes the ask rate. E.g Rs./$ 46.45 / 46.50 The bid and ask rates are always separated either by slash(/) or (-). The quote is always from the bankers point of view. Rs./$ 46.45 / 46.50 The banker is ready to buy dollar at Rs. 46.45 and sell at Rs. 46.50. i.e. Bankers buy rate= Customers sell rate. The Bid is always lower than the ask. ask rate- Bid rate = spread Merchant quote is by bank to its retail customers. Interbank quote is given by one bank to another bank.
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TT Selling Rate: applied for all clean remittances outside India i.e.,

TT Buying Rate: for purchase of foreign currency by banks where cover is already obtained by banks in India. Foreign inward remittances made payable in India Bill Selling Rate: for all foreign remittances outside India as proceeds of import bills payable in India. Bills Rate: for purchase of sight export bills which will result in foreign remittance to India after realisation. Banks also quote different rates for TC and Currency.
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for selling foreign currency to its customer by the bank issue of bank drafts, mail/telegraphic transfers etc.

There has to be a genuine underlying exposure i.e. Forward contracts are permitted only for hedging and not for speculation. A forward contract can be booked for the following:

an inward / outward remittance for export / import transactions respectively foreign currency loans / bonds - only after RBI approval, where necessary, has been obtained

The currency of hedge and tenor will be the customers choice Maturity of the hedge should not exceed the maturity of the underlying transaction
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1st: Exporter ships the goods

Importer

Importer Preference
2nd: Importer pays after goods received

Exporter

1st: Importer pays for goods

Importer

Exporter Preference
23-13

Exporter

2nd: Exporter ships the goods after being paid

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The fundamental dilemma of being unwilling to trust a stranger in a foreign land is solved by using a highly respected bank as an intermediary. Following alternatives can be used:
1.

2.

3.

4.

5.

The exporter ships the goods and deliver the documents to his Banker along with a Bill of exchange. The bank through its correspondent abroad arranges to deliver the documents of title against payment by the importer. In the above case, if the instructions are to deliver the document against acceptance, an accepted bill of exchange will be available to the exporter through the bank, which can be enforced through court in case of non payment on due date. The importer opens a Letter of Credit through his banker, which is confirmed by a Banker of exporters choice. Exporter gets the Payment from the bank when the documents as mentioned in the Letter of Credit are produced to the Bank. If the buyer demands open Account terms, International Factoring is the solution.
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Importer obtains banks promise to pay on importers behalf.

Importer
Importer pays the bank. Bank promises exporter to pay on behalf of importer.

Bank
Bank gives merchandise to the importer.

Bank pays the exporter.

Exporter
Exporter ships to the bank trusting banks promise.
23-15

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A Letter of credit is an arrangement at the request and on instructions of a customer

to make payment / authorise other bank to pay or negotiate against stipulated documents, provided that the terms and conditions are complied with.
issued by the banker of the buyer in favour of the Seller to pay a certain sum of money against presentation of documents as called for and complying with the conditions laid down in the LC.
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It is an undertaking

EXPORTER

SALE CONTRACT DEFINING TERMS

ADVICE OF OPENING LETTER OF CREDIT

IMPORTER

L/C APPLICATION

ADVISING BANK
ISSUE OF THE LETTER OF CREDIT

ISSUING BANK

17

Applicant (Opener / Importer) Issuing Bank Beneficiary (Exporter) Advising Bank Confirming Bank Negotiating Bank Reimbursing Bank

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Revocable LC: revocable before negotiation of documents. Irrevocable LC: can be revoked or amended with consent Confirmed Irrevocable LC: LC is confirmed by a Bank in the exporters Country. Transferable LC: specifically made transferable. Red Clause LC: advance payments prior to shipment. Green Clause LC: advance payments after warehousing. Back-to-back LC: Opening LC based on an existing LC. Deferred Payment LC: Payment in installments over a period. Standby LC: An undertaking to pay only in the event of non performance by the opener. Revolving LC: to make the LC available for like amount again and again. Payment made replenishes the LC amount. Restricted LC: Negotiation of documents by a particular Bank
19 19

Pre-shipment credit

for purchase, processing or packing of goods meant for exports.

Packing credit in Rupees and in FC Clean Packing Credit

Post Shipment Credit

Financial assistance extended after the shipment of exports

Factoring Forfaiting

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The objectives is to enable the exporter to : Procure raw materials. Carry out manufacturing process. Provide a secure warehouse for goods and raw materials. Process and pack the goods. Ship the goods to the buyers. Meet other financial cost of the business.

21

Issued to exporter who has the export order in his own name. Also granted to third party manufacturer/ supplier who do not have export orders in their own name. A ten digit importer exporter code number allotted by DGFT. Exporter should not be in the caution list of RBI. License issued by DGFT if the goods to be exported fall under the restricted category. If the goods to be exported are not under OGL (Open General Licence), the exporter should have the required license /quota permit to export The exporter would ship the goods and submit the relevant shipping documents to the banks within prescribed time limit. Firm order or irrevocable L/C or original cable / fax / telex message exchange between the exporter and the buyer.

22

granted against confirmed order/irrevocable LC Export order/LC should be denominated in convertible currency The rate of interest on PCFC is linked to LIBOR. The exporter has freedom to avail PCFC in convertible currencies like USD, Pound, Sterling, Euro etc. Proceeds should be realisable in convertible currency Exports in ACU currency also eligible.
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Granted to credit worthy parties where advance payment is required to be made to the supplier. Quantum determined based on the likely purchase pattern of the exporter with their suppliers. Period of CPC is determined based on the facts of each case (but not later than the period of contract/LC). A higher margin is stipulated CPC should be converted as PC or Bills.
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Finance export sales receivable after the date of shipment of goods to the date of realization of exports proceeds

Export Bills purchased/discounted. Export Bills negotiated Advance against export bills sent for collection. Advance against export on consignment basis Advance against un-drawn balance on exports Advance against claims of Duty Drawback

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Set up in 1957, for the promotion of exports To protect the exporters from any financial loss. Primary goal of ECGC : To support & strengthen the export promotion drive in India by providing a range of credit risk insurance covers to exporters against loss in export of goods and service also by offering guarantee covers to banks and financial institutions to enable exporters to obtain better facilities from them.
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Provides credit risk covers to Exporters against non payment risks of the overseas buyers / buyers country in respect of the exports made. Provides credit Insurance covers to banks against lending risks of exporters Assessment of buyers for the purpose of underwriting Preparation of country reports

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COMMERCIAL RISKS

Insolvency of buyer/LC opening bank Protracted Default of buyer Repudiation by buyer

POLITICAL RISKS

War/civil war/revolutions Import restrictions Exchange transfer delay/embargo Any other cause attributable to importing country

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UNIDROIT (Institut international pour lunification du droit prive ) is International Institute for the Unification of Private Law. UNIDROIT convention on International factoring 1988 defined factoring as: The assignment by a supplier of receivables arising from contracts of sale of goods made between the supplier and its customers to a factor, in which the factor is to perform at least two of the following functions:

Finance for the supplier Maintenance of accounts of the receivables Collection of receivables Protection against default in payment
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Factoring is a continuing arrangement between

a financial institution (THE FACTOR) and a business concern (THE CLIENT) selling goods or services to

trade customers (THE CUSTOMER)

whereby the FACTOR purchases the CLIENTs Accounts Receivables / book debts either with or without recourse to the CLIENT and administers his Sales Ledger.

30

Credit protection provided by Factors involves its undertaking to purchase Book debts / receivables, without recourse, to the Client. Without recourse, the Factor assumes the risk of default in payment by Customers only in case of Customers financial inability to pay. Under "Without Recourse" arrangement, the Factor has to pay to its Clients on the due date of the invoice.

31

Selling international accounts receivable to "Factors" It is a flexible way of managing trade debts. The goods can be sold on open account terms Factor provides professional help with credit control, debt collection and sales accounting. In India, Export Factoring is undertaken by Export Factor through an import Factor abroad. The Factoring Company (called Factor) undertake Export Factoring Activity.
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INFORMATION INDIAN EXPORTER

LETTER OF INTRODUCTION

OVERSEAS IMPORTER
C O N F I R M A T I O N

I N F O R M A T I O N

A G R E E M E N T S

EXPORT FACTOR

REQUEST FOR CREDIT COVER

IMPORT FACTOR

CREDIT COVER

INDIAN EXPORTER

CONTRACT

CONTRACT

OVERSEAS IMPORTER

D O C U M E N T S

P R E P A Y M E N T

F I N A L P A Y M E N T

F O L L O W U P

P A Y M E N T S

EXPORT FACTOR

INFORMATION ON EXPORT

IMPORT FACTOR

100 % PAYMENT

The exporter give details of his overseas customers to the Export Factor. Factor refer the same to Correspondent (Import Factor) of that country. The Import factor establishes lines of credit for each importer after verifying their credit standing. The credit line will be for the specific amount and period as per the terms of sales. The Factor fix factoring prepayment limit to the exporter who signs a factoring and credit protection agreement with the Export Factor.
35

The Exporter:

assign the receivables to the import factor Submit the export documents to the Export Factor. send the export documents to the importer. makes pre-payment of 80 to 90 per cent invoice value to the Exporter.

Export Factor:

of the

On due date:

The import factor collects the invoice value and remit to the Export Factor. Export Factor, in turn makes full payment to the exporter. Exchange control forms are disposed off.
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EXPORT FACTOR
1. 2. 3. 4. 5.

BANKS
1. 2.

Dispatch of documents Direct to the Buyer abroad in all cases. Individual follow up with the buyer in his country. 100 % Credit protection in buyers country. Trade disputes not protected. Responsibility of collection of receivables with the import factor in the buyers country. Automatic payment by the import factor after 90 days from due date. Payment from Import Factor fulfills the obligations of the exporter. Payments from import factor entitles disposal of GR forms.

Despatch thro a bank abroad in most of the cases. No such follow up If ECGC cover is available, part of the risk is covered - not 100 %. Not covered by ECGC also.

3. 4. 5.

Responsibility is with the exporter.

Claim to be submitted if ECGC cover is available. Claims settled in rupees by ECGC are not export realisation in foreign exchange. ECGC Payments do not entitle automatic closure of GR Form.

6. 7.

6. 7.

8.

8.

The Factor administers the Client's sales ledger and renders debt collection service. The amount of each invoice is made over to the Client at the end of the credit term or on an agreed maturity date, less the Factor's charges. Such factoring could be with or without recourse. If it is without recourse, the Client will get the amount regardless of whether the invoice is paid or not.

38

Export Credit Guarantee Corporation of India Ltd., (ECGC) has a product Without Recourse Export Maturity Factoring Banks offer Bill discounting facility to exporters against maturity Factoring of ECGC. Among others ECGC provides the following:100% credit guarantee protection against bad debts Regular monitoring of outstanding credits, facilitating collection on due date Recovery at its own cost all recoverable bad debts. In the event of non-realization, payment of factored receivables in Rupees, on crystallization of dues by the financing institution.
39

Forfait (French) means relinquish a right. The exporter relinquishes his right on a receivable which is due at a future date

in exchange for cash at an agreed discount, passing all the risks to the forfaitor.

It is the discount of international trade receivables on without recourse basis. Exporter is responsible only for the validity and execution of the order. Forfaitor handles the rest. Normally forfaiting is fixed interest rate and medium/ long term (up to 10 years) financing . Floating interest quotes are also available. Debt is evidenced by Bills of Exchange, Promissory Note, Letter of Credit, or Letter of guarantee.
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The importer requests credit terms. The exporter approaches a forfaiter to know his willingness to provide this credit and the costs. The forfaitor needs the following information:

The country of the importer The importer's name The type of goods The value of the goods The expected shipment date The repayment terms sought by the importer Name of the importers banker ready to guarantee his obligations
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The forfaiter indicates the costs involved. No commitment at this stage. The exporter negotiates with the importer. The exporter asks the forfaiter for a commitment to purchase the debt obligations (bills of exchange, promissory notes etc) created under the transaction. The forfaiter issues a commitment which, when accepted by the exporter, is binding on both parties
42

The commitment of forfaiter following:

contain the

Details of the underlying commercial transaction. Nature of the debt instruments to be purchased. The discount (interest) rate and other charges. The documents required in order to be satisfied that the debt being purchased is valid and enforceable The latest date that the exporter can deliver these documents to the forfaiter

The exporter signs the commercial contract with the importer and delivers the goods.
43

The importer obtains a guarantee from his bank and provides the required documents for forfaiting This exchange of documents is usually done by a bank, through a Letter of Credit. The exporter delivers the documents to the forfaiter who pays for them as agreed in the commitment The exporter has no further interest in the transaction. The forfaiter collects the future payments due from the importer and runs all the risks of non-payment.

44

2 Commercial Contract 3 Delivery of goods 5 hands over documents.

Q 1 Q 7 T P C O A O Y M P M U S I R T C C M H A E A S N S H T E

6D
D E L I V E R S O C U M E N T S

4 G U G R A I N V T E E S E

9 R E P A Y S
A T

M A T U R I T Y

8. Presents documents for Payment.

45

means unconditional and irrevocable obligation to pay In forfaiting, the importers bank avalise the debt instrument. The instrument is a Promissory Note, Bill of Exchange or Deferred Payment LC or a Letter of Guarantee. By endorsing the bill on the back, the bank commits itself unconditionally to pay should the drawee default. An "avalised" bill substitutes the importers risk by the banks risk. The bill is stamped with wording such as "Pour Aval" and signed by a representative of the bank
46

Forfaiting has been approved by RBI in 1992. Scheme available for transactions of >US $ 1-00 lakhs. The facility provided by international Forfaitor through an AD, called (Facilitator). The facilitator:

gets the quotes from the Forfaitor handles the documents. Arranges contract with the Forfaitor. Gets Exporters endorsements on the avalised instrument if any. Forwards the avalised instrument to the Forfaitor. Collects the payment form the Forfaitor. makes payment to the exporter dispose off the GR form.

47

Net amount received by the exporter should not be less than the amount realised if goods were exported on cash basis- the export amount is to be structured for this purpose. Commitment charge not to exceed 1.5% of contract value. Pass all charges to the importer to the extent possible. Forfaiting proceeds are to be received in India immediately after shipment but in any case before 180 days. Commitment charges need not be mentioned in Export Declaration Form, but discount charges to be entered in the Export Declaration form and the shipping bill. AD provides customs certificate for Export declaration form purposes.

48

Converts credit sales to cash sales. Finance up-to 100 % of the contract value Predetermined costs. Free from risk credit, political & transfer. Simple documentation. Saves cost of export insurance. Do not affect other limits with the Bank. Diversify business across the borders. Can export to even listed countries without risk. Speed Commitments within hours or days depending on details and country.

49

High value exports Capital goods Consumer durables Vehicles Consultancy and construction contracts. Project exports Bulk commodities

50

Briefly, the cost is made up of:

A charge for the money to cover the the Forfaiter's refinancing costs, calculated on the LIBOR (London Interbank Offer Rate) rate applicable to the average life of the transaction.

A charge for covering the political, commercial, and transfer risks attached to the avalor/guarantor Additional costs include a "days of grace" charge; and when necessary, a commitment fee. LIBOR. Commitment charges from the date the forfaitor is committed to undertake the forfaiting till the date of discounting may range from 0.5% to 1.5% pa Documentation fee Facilitation fee for the Bank acting as facilitator.

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Factoring Mostly domestic Consumer goods etc Short term single payment Comes after contract Continuous relationship No secondary market Supported by invoices only

Forfaiting Mostly international Mostly capital goods Longer period Payment in installments Forfaitor comes first. Single transaction available bank guarantees etc.

Infrastructure

Construction equipments

Machineries

Truckss

53