Course: BBA, Semester-5th

(Prepared By: Dr. Pinaki Mandal)

⚫ Helpful in national planning

⚫ Helpful for international financial organization

⚫ Determination of National Economic Policy.

Foreign Exchange Market

Introduction
Foreign exchange is the mechanism by which the currency of one country gets converted into the
currency of another country. The conversion of currency is done by the banks who deal in
foreign exchange. These banks maintain stocks of one currency in the form of balances with
banks. The Foreign Exchange Market is a market where the buyers and sellers are involved in
the sale and purchase of foreign currencies. In other words, a market where the currencies of
different countries are bought and sold is called a foreign exchange market.

Nature of foreign exchange

⚫ Volatile, affected by hedger, arbitrager, speculator.

⚫ Affected by demand and supply. Affected by rate of interest.

⚫ Affected by balance of payment surplus and deficit.

⚫ Affected inflation rate.

⚫ Spot and forward rates are different.

⚫ Affected by the economic stability of the country.

⚫ Affected by the fiscal policy of the government.

⚫ Affected by the political condition of the country.

⚫ It can be quoted directly or indirectly

Functions of Foreign Exchange Market

Prepared by: - Dr. Pinaki Mandal

 Course: BBA, Semester-5th
(Prepared By: Dr. Pinaki Mandal)

⚫ Transfer Function: The basic and the most visible function of foreign exchange market
is the transfer of funds (foreign currency) from one country to another for the settlement
of payments. It basically includes the conversion of one currency to another, wherein the
role of FOREX is to transfer the purchasing power from one country to another.

For example, if the exporter of India import goods from the USA and the payment is to
be made in dollars, then the conversion of the rupee to the dollar will be facilitated by
FOREX. The transfer function is performed through a use of credit instruments, such as
bank drafts, bills of foreign exchange, and telephone transfers.

⚫ Credit Function: FOREX provides a short-term credit to the importers so as to facilitate

the smooth flow of goods and services from country to country. An importer can use
credit to finance the foreign purchases. Such as an Indian company wants to purchase the
machinery from the USA, can pay for the purchase by issuing a bill of exchange in the
foreign exchange market, essentially with a three-month maturity.

⚫ Hedging Function: The third function of a foreign exchange market is to hedge foreign
exchange risks. The parties to the foreign exchange are often afraid of the fluctuations in
the exchange rates, i.e., the price of one currency in terms of another. The change in the
exchange rate may result in a gain or loss to the party concerned.

Types of Foreign Exchange Transactions

⚫ Spot Transaction: The spot transaction is when the buyer and seller of different
currencies settle their payments within the two days of the deal. It is the fastest way to
exchange the currencies. Here, the currencies are exchanged over a two-day period,
which means no contract is signed between the countries. The exchange rate at which the
currencies are exchanged is called the Spot Exchange Rate. This rate is often the
prevailing exchange rate. The market in which the spot sale and purchase of currencies is
facilitated is called as a Spot Market.

Prepared by: - Dr. Pinaki Mandal

 Course: BBA, Semester-5th
(Prepared By: Dr. Pinaki Mandal)

⚫ Forward Transaction: A forward transaction is a future transaction where the buyer and
seller enter into an agreement of sale and purchase of currency after 90 days of the deal at
a fixed exchange rate on a definite date in the future. The rate at which the currency is
exchanged is called a Forward Exchange Rate. The market in which the deals for the sale
and purchase of currency at some future date are made is called a Forward Market.

⚫ Future Transaction: The future transactions are also the forward transactions and deals
with the contracts in the same manner as that of normal forward transactions. But
however, the transaction made in a future contract differs from the transaction made in
the forward contract.

⚫ Swap Transactions: The Swap Transactions involve a simultaneous borrowing and

lending of two different currencies between two investors. Here one investor borrows the
currency and lends another currency to the second investor. The obligation to repay the
currencies is used as collateral, and the amount is repaid at a forward rate. The swap
contracts allow the investors to utilize the funds in the currency held by him/her to pay
off the obligations denominated in a different currency without suffering a foreign
exchange risk.

⚫ Option Transactions: The foreign exchange option gives an investor the right, but not
the obligation to exchange the currency in one denomination to another at an agreed
exchange rate on a pre-defined date. An option to buy the currency is called as a Call
Option, while the option to sell the currency is called as a Put Option.

Foreign Direct Investment

Introduction:- Foreign direct investment (FDI) is a direct investment into production or
business in a country by an individual or company of another country, either by buying a
company in the target country or by expanding operations of an existing business in that country.
Foreign direct investment is in contrast to portfolio investment which is a passive investment in
the securities of another country such as stocks and bonds.

Prepared by: - Dr. Pinaki Mandal

 Course: BBA, Semester-5th
(Prepared By: Dr. Pinaki Mandal)

Definitions

⚫ Broadly, foreign direct investment includes "mergers and acquisitions, building new
facilities, reinvesting profits earned from overseas operations and intra company loans".

⚫ In a narrow sense, foreign direct investment refers just to building new facilities.

Need of FDI

⚫ Improvement of Economical infrastructure

⚫ Technological Up gradation

⚫ Managing Balance of Payments

⚫ Exploitation of Natural Resources

⚫ Scope of Employment

⚫ Improvement of export

⚫ Export competitiveness

⚫ Benefit to consumers

Types of FDI
1. Greenfield investment: direct investment in new facilities or the expansion of existing facilities.
Greenfield investments are the primary target of a host nation’s promotional efforts because they
create new production capacity and jobs, transfer technology and know-how, and can lead to
linkages to the global marketplace. However, it often does this by crowding out local industry;
multinationals are able to produce goods more cheaply (because of advanced technology and
efficient processes) and uses up resources (labor, intermediate goods, etc).

2. Mergers and Acquisitions: occur when a transfer of existing assets from local firms to foreign
firms takes place, this is the primary type of FDI. Cross-border mergers occur when the assets
and operation of firms from different countries are combined to establish a new legal entity.
Cross-border acquisitions occur when the control of assets and operations is transferred from a

Prepared by: - Dr. Pinaki Mandal

 Course: BBA, Semester-5th
(Prepared By: Dr. Pinaki Mandal)

local to a foreign company, with the local company becoming an affiliate of the foreign
company.

3. Horizontal Foreign Direct Investment: is investment in the same industry abroad as a firm
operates in at home.

4. Vertical Foreign Direct Investment: Takes two forms:

 Backward vertical FDI: where an industry abroad provides inputs for a firm's domestic
production process

 Forward vertical FDI: When an MNC uses its home supplied inputs for production in host
country.

5. Conglomerate FDI: When MNC manufactures the product in foreign countries which are not
manufactured by the company at home.

6. Wholly Owned Subsidiary-A Wholly Owned Subsidiary, is an entity that is controlled

completely by another entity. The controlled entity is called a company, corporation, or limited
liability company, and the controlling entity is called its parent (or the parent company). The
reason for this distinction is that an individual cannot be a subsidiary of any organization; only
an entity representing a legal fiction as a separate entity can be a subsidiary. While individuals
have the capacity to act on their own initiative, a business entity can only act through its
directors, officers and employees. The most common example of a wholly owned subsidiary in
India is LG that was set up in 1997 as LGEIL (LG Electronics India Ltd.)

COSTS & BENEFITS OF FDI

HOST COUNTRY

 Benefits to the host country:

 Availability of scarce factors of production.

 Improvements on BOP.

 Building of economic & social infrastructure.

Prepared by: - Dr. Pinaki Mandal

 Course: BBA, Semester-5th
(Prepared By: Dr. Pinaki Mandal)

 Fostering of economic linkages.

 Strengthening of the govt. budget.

 Cost to the host country:

⚫ Strained BOP following reverse flow.

⚫ Dependence on the import of technology

⚫ Employment of expatriates.

⚫ Inappropriate technology

⚫ Unhealthy competition

⚫ Cultural & political interference.

HOME COUNTRY

 BENEFITS
 Availability of raw material
 Improvement in BOP
 Employment generation
 Revenue to the govt.
 Improved political relations
 COSTS
 Undesired outflow of factors of production

 Possibility of conflict with the host-country government.

Factors influencing FDI

1. Supply Factors-These factors influence a firms decisions relating to FDI.

 Production cost-low production cost, low labor cost low taxes etc.(example-ford plant in
Chennai-(car export to S.A)

Prepared by: - Dr. Pinaki Mandal

 Course: BBA, Semester-5th
(Prepared By: Dr. Pinaki Mandal)

 Logistics- coke and Pepsi bottling plant in India.

 Natural resources-MNC tends to utilize FDI to access natural resources that are critical
to them. Example Japan paper mill.

 Availability of quality human resource at low cost. Example- India, china, Malaysia
attracts FDI as the cost of operations of business in these countries is relatively less.

 Access to key technology- existing technology rather developing technology.

2. Demand Factors

 Customer Access- operations close to customer(fast food or service oriented and retail
outlets ) example- KFC

 Marketing Advantage- low market costs, hand on experience regarding customers,

market handling, improving customer services etc.

 Exploitation of competitive advantages- enjoys competitive advantage through

trademarks, brand name, and technology etc.

3. Political Factors
• Avoidance of trade barriers- companies establish production facilities in foreign market
to avoid trade barriers like high export tariffs, quotas etc.

• Economic Development Incentives- Government at different levels like- local, state and
national levels offer incentive.

Prepared by: - Dr. Pinaki Mandal