Forex Banking Assignment 1

1, Parallel Markets:

The parallel market, also known as the gray market, is the name given to the market that develops in
goods sold outside of their authorized channels of trade. For example, if a manufacturer of fragrances sells
a perfume in the United States and in France, and a third party purchases a large quantity of the fragrance
in France and imports it for resale in the United States, this is a parallel market transaction. The reason
that the parallel market exists is because there are generally price differentials in how the goods are sold
in different markets. This price differential allows the goods to be resold in the more expensive market at
a profit.

On the positive side the parallel market forms an arbitrage which forces prices down and provides name
brand goods at a lower price to the consumer. On the negative side, the manufacturer’s distribution
arrangements and its ability to control quality in the distribution process are undermined. Opinions on
the impact of the parallel market vary by region and industry.

As a result of these issues, legal warfare has raged around the sale of parallel market goods for over a
hundred years. This warfare sometimes takes the form of litigation and sometimes efforts at legislation. At
one time or another trademarks, copyrights, patents, coding and trade secret have all been used. Although
the legal landscape for the parallel market has become more difficult in the last few years, the business is
likely to continue for the foreseeable future.

2, Universal Banking:

Universal Banking is a multi-purpose and multi-functional financial supermarket (a company offering a

wide range of financial services e.g. stock, insurance and real-estate brokerage) providing both banking
and financial services through a single window.

Definition of Universal Banking: As per the World Bank, "In Universal Banking, large banks operate
extensive network of branches, provide many different services, hold several claims on firms(including
equity and debt) and participate directly in the Corporate Governance of firms that rely on the banks for
funding or as insurance underwriters".

In a nutshell, a Universal Banking is a superstore for financial products under one roof. Corporate can get
loans and avail of other handy services, while can deposit and borrow. It includes not only services related
to savings and loans but also investments.

However in practice the term 'universal banking' refers to those banks that offer a wide range of financial
services, beyond the commercial banking functions like Mutual Funds, Merchant Banking, Factoring,
Credit Cards, Retail loans, Housing Finance, Auto loans, Investment banking, Insurance etc. This is most
common in European countries.

For example, in Germany commercial banks accept time deposits, lend money, underwrite corporate
stocks, and act as investment advisors to large corporations. In Germany, there has never been any
separation between commercial banks and investment banks, as there is in the United States.

3, Friend ship between the Financial System and Economic Growth

 It is widely accepted that financial development is a multidimensional concept and constitutes a
potentially important mechanism for long run economic growth. The empirical evidence, including firm-
level analysis, industry-level analysis, individual country analysis and broad cross-country comparison,
suggests that there is a significant positive association between financial development and economic
growth. However, these findings do not establish the direction of causality between the two. In fact, in the
past three decades, there are copious studies that have examined the causal relationship between financial
development and long run economic growth. But these empirical findings present conflicting views,
particularly with respect to the direction of causality. That means they may/ may not cause each other. On
the one side, financial development is caused by long run economic growth when real growth has been
taken place so that the expansion of financial institutions is only a result of the need of the expansion of
the real economic activities.

Reforms to change the allocation of capital in the economy and improve the efficiency of the financial
system could raise GDP growth to 9.4% per year. In 10 years time, household per capita income would be
30%higher than without reforms, lifting millions more households out of poverty.

Source :McKinsey “Accelerating India’s Growth through Financial Reforms”

Economic Growth can be attained by:

 Improve financial system efficiency

 Improve efficiency in allocation of capital
 Mobilize more savings
 Assignment 2
1, Money market vs. capital market:
Money market involves short-term instruments (under 1 year maturity), all debt.
Capital market involves long-term instruments (more than 1 year maturity), both debt and equity.
Capital markets are for people who are willing to accept more risk and less liquidity in their investments
for a possibly higher return than money markets.

Capital market:
Basically the capital market is a type of financial market, it includes the stocks and bonds  market as well.
But in general the capital market is the market for securities where either companies or the government
can raise long term funds. One way that the companies or the government raise these long term funds is
through issuing bonds, which is where a person buys the bond for a set price and allows the government
or company to borrow their money for a certain time period but they are promised a higher return for
allowing them to borrow the money, the higher return is paid through interest that accrues on the money
that the government or company borrows.

Money market:
Basically the money market is the global financial market for short-term borrowing and lending and
provides short term liquid funding for the global financial system. The average amount of time that
companies borrow money in a money market is about thirteen months or lower. Some of the more
common types of things used in the money market are certificates of deposits, bankers' acceptance,
repurchase agreements and commercial paper to name a few.

Basically the difference between the capital markets and money markets is that capital markets are for
long term investments, companies are selling stocks and bonds in order to borrow money from their
investors to improve their company or to purchase assets. Whereas money markets are more of a short
term borrowing or lending market where banks borrow and lend between each other, as well as finance
companies and everything that is borrowed is usually paid back within thirteen months.

Another difference between the two markets is what is being used to do the borrowing or lending. In the
capital markets the most common thing used is stocks and bonds, whereas with the money markets the
most common things used are commercial paper and certificates of deposits.

2,Keynes’ Liquidity Preference Theory Of Interest

Keynes defines the rate of interest as the reward for parting with liquidity for a specified period of time.
According to him, the rate of interest is determined by the demand for and supply of money.
Demand for money: Liquidity preference means the desire of the public to hold cash. According to
Keynes, there are three motives behind the desire of the public to hold liquid cash: (1) the transaction
motive, (2) the precautionary motive, and (3) the speculative motive.
Transactions Motive: The transactions motive relates to the demand for money or the need of cash for
the current transactions of individual and business exchanges. Individuals hold cash in order to bridge the
gap between the receipt of income and its expenditure. This is called the income motive.
The businessmen also need to hold ready cash in order to meet their current needs like payments for raw
materials, transport, wages etc. This is called the business motive.
Precautionary motive: Precautionary motive for holding money refers to the desire to hold cash
balances for unforeseen contingencies. Individuals hold some cash to provide for illness, accidents,
unemployment and other unforeseen contingencies. Similarly, businessmen keep cash in reserve to tide
over unfavourable conditions or to gain from unexpected deals.
Keynes holds that the transaction and precautionary motives are relatively interest inelastic, but are
highly income elastic. The amount of money held under these two motives (M 1) is a function (L1) of the
level of income (Y) and is expressed as M1 = L1 (Y)
Speculative Motive: The speculative motive relates to the desire to hold one’s resources in liquid form
to take advantage of future changes in the rate of interest or bond prices. Bond prices and the rate of
interest are inversely related to each other. If bond prices are expected to rise, i.e., the rate of interest is
expected to fall, people will buy bonds to sell when the price later actually rises. If, however, bond prices
are expected to fall, i.e., the rate of interest is expected to rise, people will sell bonds to avoid losses.
According to Keynes, the higher the rate of interest, the lower the speculative demand for money, and
lower the rate of interest, the higher the speculative demand for money. Algebraically, Keynes expressed
the speculative demand for money as
M2 = L2 (r)
Where, L2 is the speculative demand for money, and
r is the rate of interest.
Geometrically, it is a smooth curve which slopes downward from left to right.
Now, if the total liquid money is denoted by M, the transactions plus precautionary motives by M 1 and the
speculative motive by M2, then
M = M1 + M2. Since M1 = L1 (Y) and M2 = L2 (r), the total liquidity preference function is expressed as M =
L (Y, r).
Supply of Money: The supply of money refers to the total quantity of money in the country. Though the
supply of money is a function of the rate of interest to a certain degree, yet it is considered to be fixed by
the monetary authorities. Hence the supply curve of money is taken as perfectly inelastic represented by a
vertical straight line.
Determination of the Rate of Interest: Like the price of any product, the rate of interest is
determined at the level where the demand for money equals the supply of money.  In the following figure,
the vertical line QM represents the supply of money and L the total demand for money curve. Both the
curve intersect at E2 where the equilibrium rate of interest OR is established.
If there is any deviation from this equilibrium position an adjustment will take place through the rate of
interest, and equilibrium E2will be re-established.

At the point E1 the supply of money OM is greater than the demand for money OM 1. Consequently, the rate
of interest will start declining from OR 1 till the equilibrium rate of interest OR is reached. Similarly at
OR2 level of interest rate, the demand for money OM 2 is greater than the supply of money OM. As a result,
the rate of interest OR2 will start rising till it reaches the equilibrium rate OR.
It may be noted that, if the supply of money is increased by the monetary authorities, but the liquidity
preference curve L remains the same, the rate of interest will fall. If the demand for money increases and
the liquidity preference curve sifts upward, given the supply of money, the rate of interest will rise.

Critici[Link] theory of interest has been criticized on the following grounds:

1. It has been pointed out that the rate of interest is not purely a monetary phenomenon. Real forces like
productivity of capital and thriftiness or saving by the people also play an important role in the
determination of the rate of interest.
2. Liquidity preference is not the only factor governing the rate of interest. There are several other factors
which influence the rate of interest by affecting the demand for and supply of investible funds.
3. The liquidity preference theory does not explain the existence of different rates of interest prevailing in
the market at the same time.
4. Keynes ignores saving or waiting as a means or source of investible fund. To part with liquidity without
there being any saving is meaningless.
5. The Keynesian theory only explains interest in the short-run. It gives no clue to the rates of interest in
the long run.
6. Keynes theory of interest, like the classical and loanable funds theories, is indeterminate. We cannot
know how much money will be available for the speculative demand for money unless we know how much
the transaction demand for money is.

3, The Loanable Funds Theory

Loanable funds theory is a term in economics that is used to describe money that is available to borrow. It
is another word for financial assets. The market for loanable funds is the market that brings borrowers
and savers together. In particular, loanable funds consist of bank loans and household savings.

The Facts

o Capital refers to money and the supply and demand of money in various markets. Typically, companies
and those entities that provide goods and services are the demanders of capital. In other words, borrowers
demand loanable funds, according to "Economics" by Walter J. Wessels. Similarly, households and those
entities that purchase goods and services are the suppliers of capital. In other words, savers supply
loanable funds. Furthermore, households may supply goods indirectly by saving portions of their incomes
and putting them into savings accounts (lending them to banks).

Definitions

o The interest rate is a cost of borrowing loanable funds, paid by the borrower to the lender. In other
words, it is the rate of return. Interest rates are often considered as annual percentage rates (meaning that
they are spread over a year). Compound interest is interest that is charged both on the principal balance
and the accrued, unpaid interest of a loan.
 Function

o Equlibrium of the loanable funds market occurs when savings capital is equal to the investment
capital, according to "Economics." It can be mathematically represented as National Savings = Domestic
Investment + Net Foreign Investment. The particular price that brings the loanable funds market into
equilibrium is the interest rate. In other words, loanable funds theory determines the equilibrium interest
rate of a particular loan.

Result

o When the demand and the supply curves are symbolized on the same graph, the demand curve slopes
downward. This demonstrates that borrowers will demand more money at lower interest rates. On the
other hand, the supply curve slopes upward and demonstrates that lenders are willing to supply more
money at higher interest rates. As a result, the equilibrium interest rate is the point where the supply and
the demand curves intersect.

Features

o Other considerations of the loanable funds theory is the rate of return on capital. It is important to
point out that the demand of loanable funds takes into account the additional revenue that the company
can earn from its use of the money (called the rate of return on capital). In other words, a company's
demand (just like the individual's) will continue as long as the rate of return on its capital continues to
increase.