Unit 2: International markets and derivatives
International Financial Management notes · PTU syllabus (MCOPAF312-18)
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Unit summary
Global markets offer cheaper funds and wider investment choices, and derivatives help manage the risks. This unit covers Eurocurrency and domestic interest rates, international bond and equity markets, international portfolio investment, international sources of finance, and futures, forwards, options and swaps on currencies, equities and interest rates with trading strategies.
After this unit you can
- Explain Eurocurrency markets and their relation to domestic rates
- Explain international bond and equity markets and portfolio investment
- Explain international sources of finance for Indian firms
- Explain currency, equity and interest rate derivatives and basic strategies
PTU syllabus topics
- Eurocurrency and domestic interest rates
- international bond and equity markets
- international portfolio investment
- international sources of finance
- futures/forwards/options/swaps on currency/equity/interest rates
- trading strategies
Forward
Over the counter, customised
Yes, both parties
Future
On exchange, standardised
Yes, marked to market daily
Option
Exchange or OTC
Buyer has a right, not an obligation
Swap
Over the counter
Yes: exchange of cash flows
Topic 1
Eurocurrency market
- Eurocurrency: a deposit in a currency outside its home country (Eurodollar — US$ deposited in London or Singapore); not limited to Europe.
- Features: wholesale, lightly regulated, no reserve requirements — narrower spreads than domestic markets.
- Interest rates: historically benchmarked to LIBOR; replaced by SOFR (US), SONIA (UK), €STR, and in India MIBOR alternatives for derivatives; Eurocurrency loans priced as benchmark + spread.
Topic 2
International bond and equity markets; portfolio investment
Meaning
Issued in a foreign country in that country's currency
Issued outside the country of the currency
Example
Yankee bond (US$ in USA by a non-US issuer), Samurai (yen in Japan)
US$ bond issued in London
Regulation
Host country's regulations
Lightly regulated
Masala bond
—
Rupee-denominated bond issued abroad by an Indian entity
- International equity: cross-listing; ADRs (US), GDRs (Europe/Luxembourg); direct listing of Indian companies on GIFT City IFSC exchanges (from 2024).
- International portfolio investment: gains from diversification because markets are less than perfectly correlated; home bias — investors hold too much domestic equity; risks — currency, political, information.
Topic 3
International sources of finance
| Source | Features |
|---|---|
| External commercial borrowings (ECBs) | Loans/bonds from non-residents under RBI framework; automatic route up to US$ 750 million a year (limits periodically revised by RBI) |
| ADRs and GDRs | Depository receipts representing Indian shares |
| Foreign currency convertible bonds (FCCBs) | Convertible into equity |
| Masala bonds | Rupee-denominated abroad — currency risk with investors |
| Trade credit | Supplier's/buyer's credit for imports |
| Export credit agencies | US EXIM, JBIC loans for imports |
| Multilateral agencies | World Bank, ADB, AIIB loans |
| FDI and FPI | Equity from foreign investors |
Topic 4
Derivatives on currencies, equities and interest rates
Forwards
OTC; lock future exchange rate
Futures
Exchange-traded; margins; currency futures on NSE/BSE
Options
Call (right to buy), put (right to sell); premium
Swaps
Currency swaps (exchange principal and interest in two currencies); interest rate swaps (fixed vs floating)
- 1Protective put
Own asset + buy put — insurance against fall
- 2Covered call
Own asset + sell call — earn premium, cap upside
- 3Straddle
Buy call + put at same strike — profit from big move either way
- 4Strangle
Buy out-of-the-money call and put — cheaper volatility bet
- 5Spreads
Bull and bear spreads limit risk and reward
Example
An exporter expecting US$ 1 million in 3 months buys a put option at ₹83 with a premium of ₹0.50. If the rupee strengthens to ₹81, the exporter exercises at ₹83 (net ₹82.50); if it weakens to ₹85, the exporter lets the option lapse and sells at ₹85 (net ₹84.50).
Key terms
- Eurocurrency
- Currency deposited outside its home country
- Eurobond
- Bond issued outside the country of its currency
- ADR
- Depository receipt traded in the USA representing foreign shares
- ECB
- External commercial borrowing by Indian entities
- Currency swap
- Exchange of principal and interest in two currencies
Quick revision
- Eurocurrency: wholesale, unregulated; LIBOR replaced by SOFR etc.
- Foreign bonds vs Eurobonds; masala bonds.
- ADRs/GDRs; portfolio diversification; home bias.
- Sources: ECBs, FCCBs, trade credit, multilateral loans, FDI/FPI.
- Derivatives: forwards, futures, options, swaps; option strategies.
Important exam questions
Practice questions written to the PTU exam pattern for this unit's syllabus: short answers (Section A style) and long answers (Sections B and C style).
Short-answer questions
- Q1.What is a Eurodollar?
- Q2.Distinguish a foreign bond and a Eurobond.
- Q3.What is a masala bond?
- Q4.What is an ADR?
- Q5.What is a straddle?
- Q6.What is an interest rate swap?
Long-answer questions
- Q1.Explain the Eurocurrency market and its relationship with domestic rates.
- Q2.Explain international bond and equity markets and international portfolio investment.
- Q3.Discuss international sources of finance for Indian companies.
- Q4.Explain currency and interest rate derivatives and option trading strategies.
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