An intercompany loan arranged through a bank.


Back-to-back letter of credit is one type of letter of credit (L/C). It is a form of pretrade financing in which the exporter employs the importer’s L/C as a means for securing credit from a bank, which in turn supports its L/C to the exporter with the good chance of ability to repay that the importer’s L/C represents.


Also called link financing, parallel loan, or fronting loan, a back-to-back loan is a type of swaps used to raise or transfer capital. It may take several forms:

1. A loan made by two parent companies, each to the subsidiary of the other. As is shown in Exhibit 14, each loan is made and repaid in one currency, thus avoiding foreign exchange risk. Each loan should have the right to offset, which means that if either subsidiary defaults on its payment, the other subsidiary can withhold its repayment. This eliminates the need for parent company guarantees.

2. A loan in which two multinational companies in separate countries borrow each other’s currency for a specific period of time and repay the other’s currency at an agreed maturity. The loan is conducted outside the foreign exchange market and often channeled through a bank as an intermediary.


Back-to-Back Loan by Two Parent Companies

Back-to-Back Loan by Two Parent Companies

3. An intercompany loan in which two affiliates located in separate countries borrow each other’s currency for a specific period of time and repay the other’s currency at an agreed maturity. These loans are frequently channeled through a bank. Back-to-back loans are often used to finance affiliates located in countries with high interest rates or restricted capital markets or with a danger of currency controls and different tax rates applied to loans from a bank. They contrast with a direct intercompany loan which does not involve an intermediate bank. The loan process is depicted in Exhibit 15.


Back-to-Back Loan by Two Affiliates

Back-to-Back Loan by Two Affiliates


Thailand’s currency.


The balance of payments (BOP) is a systematic record of a country’s receipts from, or payments to, other countries. In a way, it is like the balance sheets for businesses, only on a national level. The reference you see in the media to the balance of trade usually refer to goods within the goods and services category of the current account. It is also known as merchandise or “visible” trade because it consists of tangibles such as foodstuffs, manufactured goods, and raw materials. “Services,” the other part of the category, is known as “invisible ” trade and consists of intangibles such as interest or dividends, technology transfers, and others (e.g., insurance, transportation, financial). When the net result of both the current account and the capital account yields more credits than debits, the country is said to have a surplus in its balance of payments. When there are more debits than credits, the country has a deficit in the balance of payments. Exhibit 16 presents the components of each and their interrelationships. Data is collected by the U.S. Customs Service. Figures are reported in seasonally adjusted volumes and dollar amounts. It is the only nonsurvey, non-judgmental report produced by the Department of Commerce. The balance of payments appears in Survey of Current Business.


Balance of Payments Accounts

Balance Account
Sources Uses (Sources minus Uses)
1. Current Transactions
• Exports of goods • Imports of goods • Trade balance
• Exports of services • Imports of services • Invisible balance
Inward unilateral transfers Outward unilateral transfers • Net inward transfers
• Private • Private
• Public • Public
CA = Current account balance
= Net inflow from current
2. Capital Transactions
• Classified as private
versus government
• Classified by type of
• Inward portfolio • Outward portfolio • Net inward investment
investment investment
• short term • short term
• long term • long term
• Inward direct • Outward direct • Net inward investment
investment investment
KA = Capital account balance
= Net inflow from capital
3. Settling Items
3A. Central bank transactions
• Decreases in foreign • Increases in foreign • Net decreases in foreign
reserves reserves reserves (-)ARFX
3B. Errors and omissions
• Unrecorded inflows • Unrecorded outflows • Errors, omissions
Grand total of BOP 0 = CA + KA – ARFX + E&O


The balance of payments (BOP) statement is based on a double-entry bookkeeping system that is used to record transactions. Every transaction is recorded as if it consisted of an exchange of something for something else—that is, as a debit and a credit. As a general rule, currency inflows are recorded as credits, and outflows are recorded as debits. Exports of goods and services are recorded as credits. In the case of imports, goods and services are normally acquired for money or debt. Hence, they are recorded as debits. Where items are given rather than exchanged, special types of counterpart entries are made in order to furnish the required offsets. Just as in accounting, the words debits and credits have no value-laden meaning—either good or bad. They are merely rules or conventions; they are not economic truths. Under the conventions of double-entry bookkeeping, an increase in the assets of an entity is always recorded as a debit and an increase in liabilities as a credit. Thus a debit records (1) the import of goods and services, (2) increase in assets, or (3) reductions in liabilities. A credit records (1) the export of goods and services, (2) a decrease in assets, or (3) increases in liabilities.

The balance of payments statement is traditionally divided into three major groups of accounts: (1) current accounts, (2) capital accounts, and (3) official reserves accounts. We will define these accounts and illustrate them with some transactions. The double-entry system used in the preparation of’ the balance of’ payments allows us to see how each transaction is financed and how international transactions usually affect more than one type of account in the balance of payments. The illustrative transactions presented here are for the U.S. in the year 2001.

A. Current Accounts

The current accounts record the trade in goods and services and the exchange of gifts among countries. The trade in goods is composed of exports and imports. A country increases its exports when it sells merchandise to foreigners. This is a source of funds and a decrease in real assets. A country increases its imports when it buys merchandise from foreigners. This is a use of funds and an acquisition of real assets.


A U.S. manufacturer exports $5,000 in goods to a customer in Greece. According to the sales terms, this account will be paid in 90 days. In this case two things happen. The merchandise export, a reduction in real assets, provides an increase in external purchasing power—a credit entry. But the exporter is financing the transaction for 90 days; that is, the exporter’s accounts receivable have increased by $5,000. The company has made a short-term investment abroad. This acquisition of a short-term asset or claim represents a use of the country’s external purchasing power—a debit entry. In the U.S. balance of payments accounts, this transaction will appear as shown below:

Debit Credit
Increase in short-term claims
on foreigners (the accounts receivable) $5,000
Exports $5,000

The trade in services includes interest and dividends, travel expenses, and financial and shipping charges. Interest and dividends received measure the services that the country’s capital has rendered abroad. Payments received from tourists measure the services that the country’s hotels and shops provided to visitors from other countries. Financial and shipping charges to foreigners measure the fees that the financial community and ship owners charged to foreigners for the special services they rendered. In these cases the nation gave the service of assets it possessed (for example, a hotel) to foreigners. Thus, these transactions are a source of external purchasing power, in contrast to the preceding cases, when the country’s residents are the recipients of the services from foreign-owned assets and the given country loses purchasing power to the rest of the world.


A Japanese resident visits the U.S. Upon his arrival, he converts his yen into $2,500 worth of dollars at the airport bank. When the visitor departs, he has no dollars left. In this case, the U.S. provided services (such as hotel room and meals) to foreigners amounting to $2,500. In exchange for these services, U.S. banks now have $2,500 worth of yen. The willingness of U.S. banks to hold the yen balances—a liability of the Japanese government—provided the required financing for the Japanese tourist. The services that the U.S. provided to the Japanese are clearly a source of purchasing power for the U.S.—a credit entry. However, the accumulation of yen in U.S. banks is an increase in U.S. holdings of foreign financial obligations—a use of purchasing power, and thus a debit entry. In the U.S. balance of payments this transaction will appear as shown below:

Increase in short-term claims on foreigners (the yen holdings) Receipts for travel services to foreigners

Debit Credit

The exchange of gifts among countries is recorded in the unilateral transfers account. This account is also labeled remittances or unrequited transfers. A typical entry in this account is the money that emigrants send home. Another example is a gift that one country makes to another. When a country makes a gift, it can be said that it is acquiring an asset which we may call goodwill. As with any other asset acquisition, the gift represents a use of external purchasing power.


A U.S. resident who left his family in Hungary sends a $1,000 check to his wife in Hungary. The gift that the U.S. resident sent is a unilateral or unrequited transfer. For accounting purposes it can be treated as a purchase of goodwill, that reduces U.S. purchasing power (a debit entry). However, this gift was made possible by the credit or financing that the Hungarians extended to the U.S. when they accepted a financial obligation (a check) in U.S. dollars from a U.S. resident. This latter part of the transaction, an increase in liabilities to foreigners, is a source of external purchasing power (a credit entry). The entry for this transaction in the U.S. balance of payments is shown below:

Gifts to foreigners Increase in short-term liabilities to foreigners (the check)

Debit Credit

B. Capital Accounts

The capital accounts record the changes in the levels of international financial assets and liabilities. The various classifications within the capital account are based on the original term to maturity of the financial instrument and on the extent of the involvement of the owner of the financial asset in the activities of the security’s issuer. Accordingly, the capital accounts are subdivided into direct investment, portfolio investment, and private short-term capital flows. Direct investment and portfolio investment involve financial instruments that had a maturity of more than 1 year when issued initially. The distinction between direct investment and portfolio investment is made on the basis of the degree of management involvement. Considerable management involvement is presumed to exist in the case of direct investment (usually a minimum of 10% ownership in a firm), but not of portfolio investment.


A U.S. resident buys a $3,000 bond newly issued by a German company. The payment is made with a check drawn on a U.S. bank account. As a result the U.S. resident now owns a German bond, and the German company owns U.S. dollar deposits. U.S. acquisition of the German bond (a financial asset) implies a decrease in U.S. external purchasing power; the long-term investments or claims on foreigners must be debited. However, the dollar balances that the German company now owns represent an increase in U.S. liabilities to foreigners, which increases U.S. foreign purchasing power; the account short-term liabilities to foreigners must be credited. Two interpretations are possible here. We can say that the purchase of the German bond was financed with short-term liabilities issued by the U.S., or we can say that the purchase of short-term dollar instruments by the Germans was financed by their issuing a long-term bond. In the U.S. balance of payments this transaction will appear as shown as follows:

Increase in long-term claims on foreigners (the German bond) Increase in short-term liabilities to foreigners (the dollar deposits)

Debit Credit

Short-term capital movements involve financial paper with an original maturity of less than 1 year. In the previous examples, payment or financing of various transactions was made with either currency or a short-term financial note (except for the alternative interpretation of the financing of Example 21). Payments in U.S. dollars were called changes in U.S. short-term liabilities to foreigners. Payments in foreign currency were called changes in U.S. short-term claims on foreigners. These accounts are part of the short-term capital accounts. The given examples produced a net increase in short-term claims on foreigners (a debit of $7,500), and a net increase in short-term liabilities to foreigners (a credit of $4,000). A different type of entry in these accounts is presented in the next example.


A Swiss bank buys $6,000 worth of U.S. Treasury bills. It pays by drawing on its dollar account with a U.S. bank. The sale of Treasury bills to a foreigner is equivalent to U.S. borrowing external purchasing power from foreigners, an increase in liabilities to foreigners (a credit entry). However, the purchase is paid by reducing another debt that the U.S. had to foreigners (U.S. dollars in the hands of foreigners). This reduction in U.S. liabilities is a use of funds (a debit entry). In the U.S. balance of payments the transactions will be entered as shown in the following:

Decrease in short-term liabilities to foreigners (the dollar account) Increase in short-term liabilities to foreigners (the Treasury bill)

Debit Credit

C. Official Reserve Accounts

Official reserve accounts measure the changes in international reserves owned by the country’s monetary authorities, usually the central bank, during the given period. International reserves are composed mainly of gold and convertible foreign exchange. Foreign exchange reserves are financial assets denominated in such currencies as the U.S. dollar, which are freely and easily convertible into other currencies, but not in such currencies as the Indian rupee, because the Indian government does not guarantee the free conversion of its currency into others and not much of an exchange market exists. An increase in any of these financial assets constitutes a use of funds, while a decrease in reserve assets implies a source of funds. In some situations, this fact seems to run against intuitive interpretations, as when we say that an increase in gold holdings is a use of funds (signified by a minus sign or debit in the U.S. balance of payments). However, an increase in gold holdings is a use of funds in the sense that the U.S. might have chosen to purchase an alternative asset such as a bond issued by a foreign government. In order to be considered part of official reserves, the financial asset must be owned by the monetary authorities. The same asset in private hands is not considered part of official reserves. In addition, the country’s own currency cannot be considered part of its reserve assets; a country’s currency is a liability of its monetary authorities. Changes in these liabilities are reported in the short-term capital account, as illustrated previously.


An exchange trader is worried about a recent economic forecast anticipating an increased rate of inflation in the U.S. As a result, she sells $4,700 of U.S. dollars against marks (she buys marks). The transaction is done with the U.S. central bank (the Federal Reserve System). One reason the central bank may have wanted to be a party to this transaction is to support the exchange rate of the U.S. dollar (in order to prevent the possible decline in the value of the U.S. dollar that could result from the sale of the dollars by the trader). When the central bank purchases the dollars, there is a decrease in the U.S. liabilities to foreigners (a debit entry). The central bank pays for these dollars with marks it maintained as part of the country’s foreign exchange reserves. The central bank is financing the support of the exchange rate with its reserves. The decrease in the level of reserves (a financial asset) represents a credit entry. In U.S. balance of payments this transaction will appear as indicated below:

Decrease in short-term liabilities to foreigners (the dollars) Decrease in official exchange reserves (the marks)

Debit Credit

D. The Balance of Payments Statement

Exhibit 17 summarizes the transactions discussed in the examples of this section, together with some additional transactions, in a balance of payments statement for the U.S. The additional transactions are the following:

1. A foreign car, priced at $4,000 equivalent, is purchased. Payment is made with foreign currency held by the importer in the U.S.

2. A foreigner’s fully owned subsidiary in the U.S. earns $2,000 in profits after taxes. These profits are kept as part of retained earnings in the subsidiary.

3. A U.S. resident receives a $500 check in guilders as a gift from a cousin who lives abroad.

4. A U.S. company purchases 30% of a foreign candy store for $4,500. Payment is made in U.S. dollars.

5. A U.S. resident sells a $5,000 bond issued by a U.S. company to a French investor. Payment is made in U.S. dollars.

6. The U.S. central bank purchases $5,000 worth of gold to be kept as part of foreign reserves. Payment is made in U.S. dollars.


Balance of Payments for U.S. for the Year 2000*

(+: Sources of funds; Uses of funds)
Current Accounts
Merchandise account
Exports $5,000
Imports -4,000
Balance on merchandise trade $1,000
Service account
Receipts for interest and dividends, travel, and
financial charges 2,500
Payments for interest and dividends, travel, and
financial charges 2,000
Balance in invisibles (services) 500
Balance of trade in goods and services $1,500
Unilateral transfers
Gifts received from foreigners 500
Gifts to foreigners -1,000
Balance in unilateral transfers -500
Current accounts balance 1,000
Capital Accounts
Long-term capital flows
Direct investment
U.S. investment abroad
(+: decrease; -: increase) -4,500
Foreigners’ investment in U.S.
(+: increase; -: decrease) 2,000 -2,500
Portfolio investment
U.S. claims on foreigners
(-: decrease; +: increase) -3,00
U.S. liabilities to foreigners
(+: increase; -: decrease) 5,000 2,000
Balance on long-term capital -500
Basic balance 500
Private short-term capital flows
U.S. claims on foreigners
(+: decrease; -: increase) -4,000
U.S. liabilities to foreigners
(+: increase; -: decrease) 3,800
Balance on short-term private capital -200
Overall balance $300
Official Reserves Accounts
Gold exports less imports (-) $ -5,000
Decrease or increase (-) in foreign exchange 4,700
Balance on official reserves $-300

* This is also the format followed by the International Monetary Fund in its “analytic presentation” of balance of payments tables which appears in The Balance of Payments Yearbook.

Each of the tables shown in a balance of payments represents the total of the transactions affecting the given account during the reporting period. However, these totals are not calculated from entries such as the ones we have discussed. In our examples, we recorded a debit and a credit for each international transaction. In practice, the data reported in the balance of payments are gathered from sources that often are concerned with only a portion of the transactions discussed above. For example, the data presented in the import account are often collected from customs declarations, while the financing of these transactions appears largely among the data for changes in foreign assets and liabilities reported by financial institutions. That is why we often find an additional account in the balance of payments statement called errors and omissions.

The accounts in the balance of payments are often presented in a format similar to the one shown in Exhibit 17. Entries appear under the three major groupings of accounts discussed in the preceding section: current accounts, capital accounts, and official reserve accounts. The statement often supplies totals for these major groups of accounts, as well as for some of their components. In addition, as one reads from top to bottom, the typical presentation of the balance of payments provides cumulative running subtotals, usually called balances.

In Exhibit 17 the trade balance in goods and services shows a positive balance of $1,500. The sources of external purchasing power exceeded the uses on the trade accounts by $1,500. This balance is composed of a positive balance in trade in merchandise of $1,000 and a positive balance in trade in services of $500. When we add the negative balance of $500 in unilateral transfers to the balance of trade in goods and services, we obtain the balance on the current accounts. In the U.S., the current accounts balance is a surplus of $1,000.

In the long-term capital account, the U.S. had a deficit in direct investments. While foreigners invested $2,000 in the U.S. (the U.S. increased its liabilities to foreigners—a source of funds for the U.S.), the U.S. made direct investments in foreign countries in the amount of $4,500 (the U.S. acquired financial assets—a use of funds for the U.S.). Many of these investments involved acquiring whole ventures in other countries. Although in some cases the ownership had to be shared with others, the direct investor retained a substantial share (at least 10%) of the total ownership and, presumably, management. The deficit in the direct investment accounts of the U.S. was somewhat compensated for by the surplus in the portfolio accounts. Foreigners bought $2,000 more of long-term financial instruments from the U.S. than the U.S. bought from other countries. When the balance in the long-term capital accounts is added to the current accounts balance, the result is called the basic balance. The U.S. basic balance is a positive $500. In the private short-term capital accounts, foreigners bought $3,800 worth of short-term securities issued by the U.S., while the U.S. invested $4,000 in short-term securities issued by foreign countries. The sum of the private short-term capital accounts and the basic balance produces another subtotal, often referred to as the overall balance. In the U.S., the overall balance produces a surplus of $300—a net source of external purchasing power for the U.S.

By definition, the net change in official reserves must be equal to the overall balance. Given the double-entry system of accounting in the balance of payments, the net of the accounts included in any balance must equal the net of the remaining accounts. In the U.S., the surplus in the overall balance of $300 equals the increase in official reserves (a debit or minus entry) of $300. Alternatively, we can say that the total of all the entries in the U.S. balance of payments is 0.


Balance of payments adjustment is the automatic response of an economy to a country’s payments imbalances (payments deficits or surpluses). An adjustment is often necessary to correct an imbalance (a disequilibrium) of payments. Theoretically, if foreign exchange rates are freely floating, the market will automatically adjust for deficits through foreign exchange values and for surpluses through higher values. With fixed exchange rates, central banks must finance deficits, allow a devaluation, or use trade restrictions to restore equilibrium. Adjustment measures that can be taken to correct the imbalances include: (1) the use of fiscal and monetary policies to vary the prices of domestically produced goods and services vis-a-vis those made by other countries so as to make exports relatively cheaper (or more expensive) and imports more expensive (or cheaper) in foreign currency terms; and (2) the use of tariffs, quotas, controls, and the like to affect the price and availability of goods and services.


Also called merchandise trade balance or visible trade, the balance of trade is merchandise exports minus imports. Thus, if exports of goods exceed imports the trade balance is said to be “favorable” or to have a trade surplus, while an excess of imports over exports yields an “unfavorable” trade balance or a trade deficit. The balance of trade is an important item in calculating balance of payments.


Balance sheet hedging is the MNC strategy of using hedges (such as forward contracts) to avoid currency risk (i.e., translation exposure, transaction exposure, and/or economic exposure) that would potentially adversely affect the company’s balance sheet. This strategy involves bringing exposed assets equal to exposed liabilities. If the goal is protection against translation exposure, the procedure is to have monetary assets in a specific currency equal monetary liabilities in that currency. If the goal is to reduce transaction or economic exposure, the strategy is to denominate debt in a currency whose change in value will offset the change in value of future cash receipts.


Banker’s acceptance (BA) is a time draft drawn on by a business firm and accepted by a bank to be paid at maturity. A bank creates a BA by approving a line of credit for a customer. It is an important source of financing in international trade, when the exporter of goods can be certain that the importer’s draft will actually have funds behind it. Banker’s acceptances are short-term, money-market instruments actively traded in the secondary market. Depending on the bank’s creditworthiness, the acceptance becomes a financial instrument which can be discounted. In addition to the discount, an acceptance fee (usually 1.5% of the value of the draft) is charged to customers seeking acceptances.


Bank for International Settlements (, established in 1930, promotes cooperation among central banks in international financial settlements. Members include: Australia, Austria, Belgium, Bulgaria, Canada, Czechoslovakia, Denmark, Finland, France, Germany, Greece, Hungary, Iceland, and Ireland.


1. A swap between banks (commercial or central) of two or more countries for the purpose of acquiring temporarily needed foreign exchange.

2. A swap in which a bank in a soft-currency country will lend to an MNC subsidiary there, to avoid currency exchange problems. The MNC or its bank will make currency available to the lending bank outside the soft-currency country.


Barter is international trade conducted by the direct exchange of goods or services between two parties without a cash transaction.


The basic balance is a balance of payments that measures all of the current account items and the net exports of long-term capital during a specified time period. It stresses the long-term trends in the balance of payments.


A basis point is a unit of measure for the change in interest rates for fixed income securities such as bonds and notes. One basis point is equal to 1/100th of a percent, that is, 0.01%. Thus, 100 basis points equal 1%. For example, an increase in a bond’s yield from 6.0% to 6.5% is a rise of 50 basis points. A basis point should not be confused with a “point,” which represents one percent.


A bearer bond is a corporate or governmental bond that is not registered to any owner. Custody of the bond implies ownership, and interest is obtained by clipping a coupon attached to the bond. The benefit of the bearer form is easy transfer at the time of a sale, easy use as collateral for a debt, and what some cynics call “taxpayer anonymity,” signifying that governments find it hard to trace interest payments in order to collect income taxes. Bearer bonds are common in Europe, but are seldom issued any more in the United States. The alternate form to a bearer bond is a registered bond.


Also called beta coefficients, beta (P), the second letter of Greek alphabet, is used as a statistical measure of risk in the Capital Asset Pricing Model (CAPM). It measures a security’s (or mutual fund’s) volatility relative to an average security (or market portfolio). Put another way, it is a measure of a security’s return over time to that of the overall market. For example, if ABC’s beta is 1.5, it means that if the stock market goes up 10%, ABC’s common stock goes up 15%; if the market goes down 10%, ABC goes down 15%. Here is a guide for how to read betas:

Beta What It Means
0 The security’s return is independent of the market. An example is a risk-free
security such as a T-bill.
0.5 The security is only half as responsive as the market.
1.0 The security has the same reponsive or rik as the market (i.e., average
risk). This is the beta value of the market portfolio such as Standard &
Poor’s 500.
2.0 The security is twice as responsive, or risky, as the market.

Beta of a particular stock is useful in predicting how much the security will go up or down, provided that investors know which way the market will go. Beta helps to figure out risk and expected (required) return.


The higher the beta for a security, the greater the return expected (or demanded) by the investor.


XYZ stock actually returned 9%. Assume that the risk-free rate (for example, return on a T-bill) = 5%, market return (for example, return on the S&P 500) = 10%, and XYZ’s beta =1.5. Then the return on XYZ stock required by investors would be

XYZ stock actually returned 9%. Assume that the risk-free rate (for example, return on a T-bill) = 5%, market return (for example, return on the S&P 500) = 10%, and XYZ’s beta =1.5. Then the return on XYZ stock required by investors would be


Since the actual return (9%) is less than the required return (12.5%), you would not be willing to buy the stock.

Betas for stocks (and mutual funds) are widely available in many investment newsletters and directories. Exhibit 18 presents some betas for some selected MNCs:


Betas for Some Selected Multinational Corporations

Company Ticker Symbol Beta
Microsoft MSFT 1.49
Pfizer PFE 0.89
Dow DOW 0.90
Wal-Mart WMT 1.20
McDonald’s MCD 0.93
Honda HMC 0.87
Nokia NOT 1.91
IBM IBM 1.07

Note: Beta is also used to determine a foreign direct investment project’s cost of financing.


Also called a quotation or quote, bid is the price which a dealer is willing to pay for (i.e., buy) foreign exchange or a security.


The bid-ask spread is the spread between the bid (to buy) and the ask (to sell or offer) price and represents a transaction cost. It is based on the breadth and depth of the market for that currency as well as on the currency’s volatility.


A Swiss francs quote of, say, $0.7957-60 means that the bid rate is $0.7957 and the ask rate is $0.7960. The bid-ask spread is usually stated in terms of a percentage cost and calculated as follows:



On Monday, February 21, 2000, the bid-ask spread on the Japanese yen was ¥110.886 – 936. (Source: Olsen and Associates; Then the percent spread is: [(¥110.936 -¥110.886)/¥110.936] x 100 = 0.004507%.

The bid-ask spread is the discount in the bid price as a percentage of the ask price. A spread of less than 1/10 of 1% is normal in the market for major traded currencies. Note: When quotations in American terms are converted to European terms, bid and ask reverse. The reciprocal of the bid becomes the ask, and the reciprocal of the ask becomes the bid.


Also called the buying rate, bid rate is the rate at which a bank buys foreign currency from a customer by paying in home currency.


1. Advocating drastic changes in the policies of a country or an MNC.

2. The liberalization of the London capital markets that transpired in the month of October 1986.


Currencies participating in the European Economic and Monetary Union (EMU) are units of the euro until January 1, 2002. To convert one currency to another, you must use the triangulation method: Convert the first currency to the euro and then convert that amount in euros to the second currency, using the fixed conversion rates adopted on January 1, 1999 (see Exhibit 19).


Fixed Euro Conversion Rates

Currency Literacy
Country Currency Abbreviation Rate
Euroland euro EUR 1
Austria schilling ATS 13.7603
Belgium franc BEF 40.3399
Finland makka FIM 5.94573
France franc FRF 6.55957
Germany mark DEM 1.95583
Ireland punt IEP .787564
Italy lira ITL 1,936.27
Luxembourg franc LUF 40.3399
Netherlands guilder NLG 2.20371
Portugal escudo PTE 200.482
Spain peseta ESP 166.386


Also called a draft, a bill of exchange (B/E) is an unconditional written agreement between two parties, written by an exporter instructing an importer or an importer’s agent such as a bank to pay a specified amount of money at a specified time. Examples are acceptances or the commercial bank check. The business initiating the bill of exchange is called the maker, while the party to whom the bill is presented is called the drawee.


The bill of lading (B/L) is a receipt issued to the exporter by a common carrier that acknowledges possession of the goods described on the face of the bill. It serves as a contract between the exporter and the shipping company. If it is properly prepared, a bill of lading is also a document of title that follows the merchandise throughout the transport process. As a document of title, it can be used by the exporter either as collateral for loans prior to payment or as a means of obtaining payment (or acceptance of a time draft) before the goods are released to the importer. There are different types of B/L:

1. A negotiable or shipper’s order B/L can be bought, sold, or traded while goods are in transit.

2. A straight B/L is nether negotiable nor transferable.

3. An order B/L is cosigned to the exporter who keeps title to the merchandise until the B/L is endorsed.

4. An on-board B/L certifies that the goods have been actually placed on board the ship.

5. A received-for-shipment B/L simply acknowledges that the goods have been received for shipment.


A bill of sale is a written document which transfers goods, title, or other interests from a seller to a buyer and specifies the terms and conditions of the transaction.


Black markets are illegal markets in foreign exchange. Developing nations generally do not permit free markets in foreign exchange and impose many restrictions on foreign currency transactions. These restrictions take many forms, such as limiting the amounts of foreign currency that may be purchased or having government licensing requirements. As a result, illegal markets in foreign exchange develop to satisfy trader demand. In many countries such illegal markets exist openly, with little government intervention.


An option pricing equation developed in 1973 by Fischer Black and Myron Scholes provides the relationship between call option value and the five factors that determine the premium of an option’s market value over its expiration value:

1. Time to maturity—the longer the option period, the greater the value of the option;

2. Stock price volatility—the greater the volatility of the underlying stock’s price, the greater its value;

3. Exercise price—the lower the exercise price, the greater the value;

4. Stock price—the higher the price of the underlying stock, the greater the value; and

5. Risk-free rate—the higher the risk-free rate, the higher the value.

The formula is:




1. The value of the option increases with the level of stock price relative to the exercise price [P/PV(E)], the time to expiration, and the time to expiration times the stock’s variability (ojt).

2. Other properties:

a. The option price is always less than the stock price.

b. The option price never falls below the payoff to immediate exercise (P – E or zero, whichever is larger).

c. If the stock is worthless, the option is worthless.

d. As the stock price becomes very large, the option price approaches the stock price less the present value of the exercise price.


The current price of Sigma Corporation’s common stock is $59.375 per share. A call option on this stock has a $55 exercise price. It has 3 months to expiration. If the standard deviation of continuously compounded rate of return on the stock is 0.2968 and the risk-free rate is 5% per year, the value of this call option is:

First, calculate the time until the option expires in years,


Second, calculate the values of the other variables:


Next, use a table for the standard normal distribution to determine N(d1) and N(d2):


Finally, use those values to find the option’s value:


This call option is worth $5.05, a little more than its value if it is exercised immediately, $4.375 ($59.375 – $55), as one should expect.


You want to determine the value of another option on the same stock that has an exercise price of $50 and expires in 45 days. The time until the option expires in years is t in years = 45 days/365 days = 0.1233.

The values of the other variables are:


Next, use a table for the standard normal distribution to determine N(d1) and N(d2):


Finally, use those values to find the option’s value:


The call option is worth more than the other option ($9.78 versus $5.05), because it has a lower exercise price and a longer time until expiration.


Blocked funds are funds in one nation’s currency that may not be exchanged freely due to exchange controls or other reasons.


Venezuela’s currency.


Bolivia’s currency.


Brady bonds are bonds issued by emerging countries under a debt-reduction plan and are named after a former U.S. Secretary of the Treasury. They are traded on the international bond market.


Break-even analysis is used to determine the amount of currency change that will equate the cost of local currency financing with the cost of home currency (dollar) financing. In general, the break-even rate of currency change is found as follows:



Suppose that a U.S. firm in Switzerland is given a one-year loan at the quoted interest rate of 8% locally. The firm could also have borrowed funds in the U.S. for one year at 12%. Then


Which means the Swiss franc appreciation should equal 3.7% before it becomes less expensive to borrow dollars at 12% than Swiss franc at 8%.

In making investments, investors should use the following rules:

* *

(a) For an expected devaluation, if d < d , borrow dollars, and if d > d , borrow the foreign currency.


(b) For an expected revaluation, if d > d , borrow dollars, and if d < d , borrow the foreign currency.


Bretton Woods Agreement is an agreement, implemented at an international conference with representatives of 40 countries in Bretton Woods, New Hampshire, that established the international monetary system in effect from 1945 to 1971. Each member government pledged to maintain a fixed, or pegged, exchange rate for its currency with respect to the U.S. dollar or gold. These fixed exchange rates were intended to reduce the riskiness of international transactions, thus promoting growth in global trade.


A conference in 1944 in which representatives of 40 nations gathered to map a new international monetary system. They established the International Monetary Fund, the World Bank, and an international monetary system at Bretton Woods, New Hampshire.


The currency of one of the United States’ top allies and trading partners, the British pound is one of the world’s most important currencies. Its relationship to the U.S. dollar is a key to the global marketplace and is seen as a barometer of the United Kingdom’s economic strength versus the business climate in the United States.


The brokers’ market is the market for exchange of financial instruments between any two parties using a broker as an intermediary or agent. Along with the interbank market, the broker’s market provides another area of large-scale foreign exchange dealing in the United States. A good number of foreign exchange brokerage firms make markets for foreign currencies in New York (as well as in London and elsewhere), creating trading in many currencies similar to that in the interbank market. The key differences are that the brokers (1) seek to match buyers and sellers on any given transaction, without taking a position themselves; (2) deal simultaneously with many banks (and other firms); and (3) offer both buy and sell positions to clients (where a bank may wish to operate on only one side of the market at any particular time). Also, the brokers deal “blind,” offering rate quotations without naming the potential seller/buyer until a deal has been negotiated.


Bulldogs are sterling-denominated bonds issued within the United Kingdom by a foreign borrower. They are foreign bonds sold in the United Kingdom.


The Bundesbank is the German central bank equivalent to the Federal Reserve System of the U.S. Its primary goals are to (1) set the discount rate, known as the Lombard rate; (2) monitor the money supply; and (3) back economic (fiscal and monetary) policies.


Also called cash burn rate, burn rate is how quickly a company uses up its capital to finance operations before generating positive cash flow from operations. This rate is a critical key to survival in the case of small, fast growing companies that need constant access to capital. Many technology and Internet companies are examples. It is not uncommon for enterprises to lose money in their early goings, but it is important for financial analysts and investors to assess how much money those firms are taking in and using up. The number to examine is free cash flow, which is the company’s operating cash flows (before interest) minus cash outlays for capital spending. It is the amount available to finance planned expansion of operating capacity. Burn rate is generally used in terms of cash spent per month. A burn rate of 1 million would mean the company is spending 1 million per month. When the burn rate begins to exceed plan or revenue fails to meet expectations, the usual recourse is to reduce the burn rate. In order to stay afloat, the business will have to reduce the staff, cut spending (possibly resulting in slower growth), or raise new capital, probably by taking on debt (resulting in interest expense) or by selling additional equity stock (diluting existing shareholders’ ownership stake).


Secure-payments provider Cyber Cash had $26.4 million in cash at the end of March, and at its current burn rate of $7 million to $8 million per quarter, only has enough cash to last it through next February. The company generated just $155,000 in revenue in its most recent quarter. Once you have a burn rate such as this and reserves insufficient to cover your cash needs for a year, you have problems.

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