International Finance: Exercise Solutions
How to Use This Page
Read the Samacheer Kalvi textbook chapter first. Then use this page to revise: attempt the textbook questions on your own, then compare with the model answers below. Pay special attention to the Common Mistakes section and the Exam Checklist before your test.
Key Concepts (Quick Recap)
| Term | Definition |
|---|---|
| International Finance | Section of financial economics dealing with monetary interactions between two or more countries |
| GDR (Global Depositary Receipt) | Instrument issued abroad by a company to raise funds in foreign currencies, listed on non-US stock exchanges |
| ADR (American Depositary Receipt) | Dollar-denominated negotiable certificate representing a non-US company, traded on US exchanges |
| FCCB (Foreign Currency Convertible Bond) | Special type of bond issued in a currency other than the home currency, convertible into equity |
| FDI (Foreign Direct Investment) | Investment by a company/individual in one country in business interests of another country with management control |
| FII (Foreign Institutional Investor) | Investment by a non-resident in equity of a domestic company without intention of acquiring management control |
| ODB (Overseas Depository Bank) | Bank in the foreign country that issues GDRs on behalf of the domestic company |
| DCB (Domestic Custodian Bank) | Bank in the home country that holds shares and coordinates with the overseas depository bank |
| ECB (External Commercial Borrowing) | Loans raised by Indian companies from foreign sources in foreign currency |
| Direct Quote | Foreign currency is fixed, local currency is variable |
| Indirect Quote | Local currency is fixed, foreign currency is variable |
I. Choose the Correct Answer (MCQ)
Q1. An instrument representing ownership interest in securities of a foreign issuer is called ……… (a) Share (b) A depositary receipt ✓ (c) Bond (d) Debenture
Q2. Issuance of DRs is based on the increase of demand in the ……… (a) International market ✓ (b) Domestic market (c) Local market (d) Capital market
Q3. ADRs are issued in ……… (a) London (b) Luxembourg (c) India (d) The USA ✓
Q4. Depositary receipts traded in an international market other than the US are called ……… (a) Global Depositary Receipts ✓ (b) American Depositary Receipts (c) Foreign Currency Convertible Bond (d) FCCB
Q5. ……… bond is a special type of bond issued in a currency other than the home currency. (a) Convertible bond (b) Foreign Currency Convertible Bond ✓ (c) Zero coupon bond (d) Secured bond
Q1 (Additional). ……… is a section of financial economics that deals with monetary interactions between two or more countries. (a) International finance ✓ (b) Domestic finance (c) Public finance (d) Corporate finance
Q2 (Additional). If the local currency is in variable form and foreign currency is in fixed form, quotation will be ……… (a) Indirect ✓ (b) Direct (c) Cross (d) Forward
Q3 (Additional). ……… is an instrument issued abroad by a company to raise funds in foreign currencies and is listed on a foreign stock exchange. (a) GDR ✓ (b) ADR (c) FCCB (d) FDI
Q4 (Additional). The bank that holds shares of the company and coordinates with the overseas depository bank is called ……… (a) Overseas Depository Bank (b) Domestic Custodian Bank ✓ (c) Central Bank (d) Merchant Bank
Q5 (Additional). FCCB holders have the right to convert bonds into ……… after a certain period. (a) Fixed deposits (b) Equity shares or depository receipts ✓ (c) Debentures (d) Preference shares
Q6 (Additional). FII investment in India has been allowed since ……… (a) 1990 (b) 1992 ✓ (c) 1995 (d) 1991
II. Fill in the Blanks
1. GDR stands for Global Depositary Receipt. 2. ADR stands for American Depositary Receipt. 3. FCCB stands for Foreign Currency Convertible Bond. 4. FDI stands for Foreign Direct Investment. 5. FII stands for Foreign Institutional Investor. 6. ADRs are denominated only in US dollars. 7. GDRs can be denominated in any freely convertible currency. 8. ADR requires approval from SEC (Securities and Exchange Commission) of the USA. 9. The Domestic Custodian Bank is abbreviated as DCB. 10. ECB stands for External Commercial Borrowing. 11. ADRs are traded on the American stock exchange. 12. GDRs are traded on non-US stock exchanges such as London and Luxembourg. 13. The number of FIIs registered with SEBI is over 1450. 14. In ADR issuance, the American Depository Bank (ADB) converts the issue from rupees into US dollars. 15. In GDR issuance, the Overseas Depository Bank (ODB) converts shares into GDR denominated in foreign currency.
III. True or False (with corrections)
1. GDRs are traded only on American stock exchanges. False. GDRs are traded on non-US stock exchanges such as London and Luxembourg. ADRs are traded on American stock exchanges.
2. FDI involves acquiring management control in a foreign company. True.
3. FII gives the investor management control over the domestic company. False. FII is portfolio investment without the intention of acquiring management control.
4. FCCB is a secured debt instrument. False. FCCB is an unsecured convertible debt instrument carrying an interest coupon.
5. ADRs require SEC approval for issuance. True.
6. GDRs are denominated only in US dollars. False. GDRs can be denominated in any freely convertible currency. ADRs are denominated only in US dollars.
7. FCCB is an equity instrument. False. FCCB is a convertible debt instrument (not equity). It carries an interest coupon and can be converted into equity after a certain period.
8. FDI creates only short-term portfolio investment. False. FDI involves long-term investment with management control. It is FII that creates short-term portfolio investment without management control.
IV. Match the Following
| Column A | Column B |
|---|---|
| 1. GDR | (c) Issued on non-US exchanges |
| 2. ADR | (e) Denominated only in US dollars |
| 3. FCCB | (a) Convertible debt instrument |
| 4. FDI | (d) Investment with management control |
| 5. FII | (b) Portfolio investment without management control |
V. Answer Briefly
Q1. Who are Foreign Institutional Investors (FII)? An investment made by a Non-resident in the equity of a domestic company without the intention of acquiring management control.
Q2. What is a Depository Receipt? A negotiable financial instrument issued by a bank to represent a foreign company's equity shares or securities. They are issued to attract a greater amount of investment from other countries.
Q3. What is a GDR (Global Depository Receipt)? An instrument issued abroad by a company to raise funds in some foreign currencies and is listed and traded on a foreign stock exchange.
Q4. What is an American Depositary Receipt (ADR)? A dollar-denominated negotiable certificate representing a non-US company in the US market which allows US citizens to invest in overseas securities.
Q5. What is a Foreign Currency Convertible Bond? A special type of bond issued in a currency other than the home currency. Companies issue FCCBs to raise money in foreign currency.
Q6 (Additional). Define Foreign Direct Investment (FDI): An investment made by a company or individual in one country with business interests in another country, in the form of either establishing business operations or acquiring business assets in the other country.
Q7 (Additional). Expand the following: 1. GDR: Global Depositary Receipt 2. ODB: Overseas Depository Bank 3. DCB: Domestic Custodian Bank 4. ECB: External Commercial Borrowing
VI. Answer in Detail
Q1. Importance of international finance: 1. International finance helps calculate exchange rates of various currencies and the relative worth of each and every nation. 2. It helps compare the inflation rates and get an idea about investing in international debt securities. 3. It helps ascertain the economic status of various countries and judge the foreign market. 4. International Financial Reporting System (IFRS) facilitates comparison of financial statements made by various countries. 5. It helps understand the basics of international organisations and maintain the balance among them. 6. Organisations such as IMF, World Bank, etc. mediate and resolve financial disputes among member nations.
Q2. Distinguish between GDR and ADR:
| Sl.No | Basis | GDR | ADR |
|---|---|---|---|
| 1 | Denomination | Denominated in any freely convertible currency | Denominated only in US dollars |
| 2 | To whom issued | Issued to investors in one or across more markets simultaneously | Issued only to US residents |
| 3 | Listed in | Non-US Stock Exchange (e.g., London or Luxembourg) | American stock exchange |
| 4 | Approval | Does not require foreign regulatory clearances | Requires SEC (USA) approval |
| 5 | Mode of expression | Correlated to equity shares expressed in whole numbers | Often correlated to equity shares expressed as a fraction |
| 6 | Negotiation | Negotiable all over the world | Negotiable only in America |
Q3. Five features of FCCB: 1. FCCB is issued by an Indian company in foreign currency. 2. These are listed and traded in the foreign stock exchange and similar to debentures. 3. It is a convertible debt instrument carrying an interest coupon and is unsecured. 4. It gives its holders the right to convert for a fixed number of shares at a predetermined price. 5. It can be converted into equity or depository receipt after a certain period.
Q4. Five advantages of FDI: 1. Achieving Higher Growth in National Income — Developing countries get much-needed capital through FDI to achieve a higher rate of growth. 2. Help in Addressing BOP Crisis — FDI provides an inflow of foreign exchange resources, helping solve the adverse balance of payment position. 3. Faster Economic Development — FDI brings technology, management, and marketing skills crucial for achieving faster economic development. 4. Generating Employment Opportunities — FDI generates employment opportunities in developing countries, especially in high-skill areas. 5. Encouraging Competition in Host Countries — FDI promotes healthy competition, leading enterprises to operate efficiently; consumers get variety and quality at market-determined prices.
Q5. Disadvantages of FDI: 1. Exploiting Natural Resources — FDI companies deplete resources like water, forest, mines. 2. Heavy Outflow of capital — Foreign companies take away huge funds as dividends, royalty fees, etc. 3. Not Transferring Technology — Some foreign enterprises transfer only second-hand technology. 4. Exploiting Cheap Labour — Foreign enterprises employ cheap labour at lower pay, do not employ locals for higher management posts. 5. Creating Monopolistic Environment — MNCs entering through FDI may create monopolistic conditions through market power.
Q6. Note on FII: FII is defined as an investment made by a Non-resident in equity of a domestic company without intending to acquire management control. Organizations like hedge funds, insurance companies, pension funds, and mutual funds qualify as institutional investors. Since 1992, FIIs have been allowed to invest in all securities traded on primary and secondary markets. Over 1450 FIIs have registered with SEBI.
Q7. International sources from where funds can be generated:
- Commercial Banks — Most commercial banks extend foreign currency loans for promoting business opportunities.
- International Agencies and Development Banks — They promote international trade and business, providing term loans and grants. IFC, EXIM Bank, and Asian Development Bank operate at the international level.
- International Capital Markets — Modern organisations and multinational companies depend on sizeable borrowings in rupees and foreign currencies, using Depository Receipts as prominent instruments.
Q8. Procedure for issuing ADR: 1. The company hands over shares to a Domestic Custodian Bank (DCB). 2. DCB requests the American Depository Bank (ADB) to issue shares as ADRs. 3. ADB converts the issue from rupees into US dollars. 4. ADB issues them to intending investors.
Q9. Process of issuing GDR: 1. The company hands over its shares to a Domestic Custodian Bank (DCB). 2. DCB requests the Overseas Depository Bank (ODB) in the foreign country for issuing shares as GDR. 3. ODB converts the shares shown in rupees into GDR denominated in US dollars. 4. ODB issues them to intending investors.
Q10. Distinguish between FDI and FII:
| Basis | FDI | FII |
|---|---|---|
| Meaning | Investment with intention of acquiring management control | Investment without intention of acquiring management control |
| Nature | Long-term investment | Short-term or medium-term investment |
| Control | Gives voting rights and management control | No management control |
| Entry | Direct entry into business | Entry through stock markets |
| Examples | Setting up factories, acquiring companies | Buying shares, debentures |
Q11. Note on External Commercial Borrowings (ECB): ECBs are loans raised by Indian companies from foreign sources in foreign currency. They help companies access cheaper international capital. ECBs include buyers' credit, suppliers' credit, and foreign currency bonds. Companies must follow RBI guidelines on minimum maturity periods and interest rate ceilings when raising ECBs.
Common Mistakes to Avoid
1. GDR vs ADR — GDR is global (any currency, any exchange), ADR is American-only (US dollars, US exchange, SEC approval required). Don't mix them up. 2. FDI vs FII — FDI involves management control and long-term investment; FII is portfolio investment without management control. 3. FCCB is unsecured — It is a convertible debt instrument, not equity. It carries an interest coupon. 4. ADR requires SEC approval — GDR does not require foreign regulatory clearances. 5. FII investment since 1992 — Not earlier; this is a frequently tested fact. 6. GDR is denominated in foreign currency — But the underlying shares are denominated in the local (issuer's) currency.
Exam Checklist
- [ ] Can distinguish GDR and ADR (6-point table)
- [ ] Can list 5 features of FCCB
- [ ] Can list 5 advantages and 5 disadvantages of FDI
- [ ] Know the procedure for issuing ADR and GDR (4 steps each)
- [ ] Can define FII and FDI
- [ ] Know expansions: GDR, ADR, FCCB, FDI, FII, ODB, DCB, ECB
- [ ] Can explain the importance of international finance (6 points)
- [ ] Know international sources of funds (commercial banks, development banks, capital markets)
- [ ] Can list 3 disadvantages of FDI (exploiting resources, capital outflow, not transferring technology)
- [ ] Know the FII registration count with SEBI (over 1450)
- [ ] Can distinguish FDI vs FII (management control, long-term vs short-term)
- [ ] Know ECB (External Commercial Borrowing) and its meaning