INSTITUTE OF BANKERS IN MALAWI
DIPLOMA IN BANKING EXAMINATION
SUJECT:
INTERNATIONAL TRADE FINANCE (IOBM-D202) - NOV 2012
SECTION A
Answer ALL Questions
Question 1.
(a)
Explain the ”Mercantilist Theory of Trade and mention the system that replaced this
theory? (5 Marks)
The mercantilist theory of trade was based on nationalism and the desire to develop
national power and was based on the view that the most essential thing for a country
was to become rich and powerful by exporting more goods in order to achieve balance
of payments.
This was later replaced industrial revolution which removed the restrictive bonds of a
protectionist mercantile socity and quickened the pace of international trade.
(b)
State Adam Smith’s Theory of trade and illustrate how countries stand to benefit from
specialization ( 5 marks)
Adam Smith argued that with free and voluntary trade countries could specialize in
the production of those goods and services in which they had an absolute advantage
over other nations
Tobacco
Copper
Zambia
2
12
Malawi
4
2
According to the table Zambia has an absolute advantage over Malawi in the
production of copper while Malawi has an absolute advantage in the production of
tobacco. If Zambia specialized in the production of copper and Malawi specialized in
the production of tobacco both countries would benefit through trade.
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(c)
Assume you are buying a vehicle from UAE the price quoted is US$ 5,000.00 The US$ /
Malawi Kwacha exchange rate on the day you were quoted is 1 US$ = MK 160.00
I.
II.
III.
(d)
Calculate the cost of the car to you in Malawi Kwacha (2 Marks)
Suppose at the time of paying for the car, the US$ / MWK exchange rate is now
US$1 = MWK 180.00 calculate the additional cost of the car in Malawi Kwacha
( 2marks )
Explain the effect of a strong dollar to you as an importer, as well as an exporter
. Quantify your answer by showing your calculations. ( 2marks)
Explain two reasons why the mere acceptance of the bill of exchange by the
importer is not a guarantee that payment will be made? (2 Marks)
Banks involved do not provide any guarantee of payment
Question 2.
Explain briefly, by giving examples, how the following will affect the exchange rate of a country’s
currency:
(a) Rate of inflation. (3 marks)
High inflation makes a country less competitive internationally and, therefore, tends to cause
deterioration in the current account. Currency movements under a generalized system of floating
exchange rates should, according to the purchasing power parity (PPP) theory, respond primarily
to inflation differentials. High inflation could lead to a weakening of a currency to the point where
the rate is again the equilibrium rate, reflecting purchasing power parity.
(b) Leads and lags. (3 marks)
Market observers have noted that market participants not only act on the basis of known
facts and figures, they also go according to expectations
Leads: Importers expecting a fall in the value of the Malawi Kwacha, will rush to pay in
currency (or sell currency) ahead of time normally chosen for their payments (selling). This is
very typical in Malawi as the foreign exchange availability if often seasonal.
Lags: exporters (also expecting a falling Malawi Kwacha) will delay (lag) the sale of their
export proceeds or payment of their obligations.
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A combination of leads and lags will very soon produce a deteriorating balance of payments
and worsening trade balance. Imports will increase dramatically and exports will reduce, thus
leads and lags that were set in motion possibly by only minor deficiencies could actually
create a major currency crisis
(c) Economic position. (3 marks)
Ordinarily, faster economic growth of one country than other countries tends to cause
deterioration in the trade balance in cases where imports rise faster than exports.
On the other hand, this may attract foreign capital in the form of securities investments or
direct investments. Good economic growth prospects could induce foreign investors to invest
in such a country rather than other non-performing economies.
Generally, it is expected that currency of a country with a rising economy will strengthen as
investors come in with foreign currency while the currency of a country in economic problems
will weaken as investors are moving out of the country with foreign currency.
(d) Hot money. (3 marks)
This is a very substantial quantity of international money which is available for investment (or
speculation). Hot money “flows” into a country when interest rates are higher than in other
countries, or when there is speculation that the currency’s exchange rate will appreciate. Just
as hot money flows into a country, it just as quickly flow out, putting speculative pressure on
the country’s currency to weaken.
When hot money is used for investment, the investors will probably cover forward by selling
the currency when the investment matures. In this situation, hot money would, therefore,
affect both spot rates (purchase of investment) and forward rates (at sale of proceeds of
investments).
(e) Hedging. (3 marks)
Traders that would like to protect themselves against heavy foreign exchange losses through
hedging will actively activate forward, options and other hedging products. This leads to
speculation on exchange rate movement and affects the current exchange rates.
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Question 3.
(a)
The following information relates to transactions in a treasury section of bank on 27 February
2012:
Bought £250,000 @ 280
Sold US$120,000 @ 175
Sold £100,000 @ 290
Bought US$25,000 @ 170
Summarise the information above by preparing a deal blotter showing the closing positions for
each foreign currency. (8 marks)
Answer
Deal
1
US$
2
3
-120,000
4
+25,000
£
+250,000
-100,000
Rate
280
175
290
170
MK
+70,000,000
-21,000,000
-29,000,000
4,250,000
Net +MK24,250,000
(b)
Explain the risk exposure to the bank created by the transactions. (2 marks)
Answer
This shows that the branch has closed with a short position. This means that more foreign currency
has been bought than sold. The risk about this position is the strengthening of the local currency since
it will result in incurring foreign exchange losses.
(c )
Describe two payment mechanisms in international trade. (2 Marks)
Clean payments- open account or payment in advance
Documentary collections
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(d)
Define a Bankers Acceptance (3 Marks)
A Bankers Acceptance is a short term credit instrument created by a non financial
firm and guaranteed by a bank to make payment. It is a negotiable time draft for
financing imports, exports and other transactions.
Question 4
(a)
State two advantages and disadvantages for the use of advance payments (4 Marks)
Exporter receives cash before hand i.e before parting with goods
Exporter avoids currency changes
Risk of exporter absconding the release of goods
Cash-flow problem to the importer
(c)
Define a documentary collection. Mention two different ways in which documentary
collections are carried out (6 Marks)
A method of payment used in international trade where by the exporter entrusts the
handling of commercial and financial documents to the importer. Banks involved do
not provide guarantee for payment
( d)
State the difference between Confirmed Irrevocable letter of credit and unconfirmed
irrevocable letter of credit ( 5 marks )
A confirmed Irrevocable letter of credit is a definite undertaking by a bank where the
importers bank irrevocably commits itself to the exporter and confirming bank adds
its commitment and assumes the responsibility to pay the exporter if the presentation
of the documents is in good order. For Unconfirmed Letter of credit the exporters
bank is under no obligation to pay . Payment is the sole responsibility of the
importers bank.
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SECTION B
( 40 marks )
Answer ANY TWO questions from this section.
Question 5. ( Total 20 marks)
From International Trade Finance HandBook
Chapter 5, Section 5.4 (Sub sections 5.4.1 to 5.4.3) Mechanics- How
does a documentary collection work.
The Principal
• Also called the drawer, seller or exporter
The Remitting Bank
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• The principal’s bank that remits the documents to the collecting bank on behalf of
the principal
The Collecting Bank
• The correspondent of the remitting bank; collecting and presenting bank may be
the same bank
The Presenting Bank
• The bank presenting the collection to the drawee and obtaining payment from the
drawee
The Drawee
• Also known as the buyer or importer
• The party to whom the presenting bank presents the collection
( 5 marks for identifying parties and extra 5 marks for defining their roles in
the documentary collection process.)
Modus Operandi (follow the steps and sequence from the diagram above)
(1) The buyer (“drawee”) and seller (“principal/drawer”) conclude the sales contract
(2) The principal ships the goods to the drawee
(3) The principal hands the documents to the remitting bank with instructions to
release the documents:
(3.1) against payment of the amount owed; or
(3.2) against acceptance of a bill of exchange
(4) The remitting bank forwards the documents to the collecting bank in the drawee’s
country
(4.1) The collecting bank could be the drawee’s bank or a bank nominated
the remitting bank
by
(4.2) If the collecting bank is not the drawee’s bank, then the collecting bank
forwards the documents to the drawee’s bank (the presenting bank) to present
the documents to the drawee
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(4.3) The presenting bank must communicate and effect payment through the
collecting bank; they cannot communicate direct with the remitting bank
(5) The collecting/presenting bank releases the documents to the drawee as per
instructions received from the remitting bank
(6) The buyer clears the goods
(7) The collecting/presenting bank obtains payment from the drawee and effects
payment to the remitting bank for credit to the principal’s account
(7 marks, the yellow highlighted area, if not mentioned, will not attract
penalties for students)
(3 marks for drawing the diagram and correct labeling)
(Where the student correctly draws the diagram and correctly labels it with
parties to the collection and the above 7 sequences without explaining
separately, they get the full 20 marks)
Question 6
(a)
Letter of credit: Makwasa should advise the customer to apply for letter of credit in
favour of Makwasa as a means of settlement of the sale contract. The issuing bank will
be based in Sweden and the confirming bank in Malawi. Makwasa will receive payment
upon presentation of documents specified in the letter of credit such as shipping
documents. Invoices and insurance certificates to the confirming bank in Malawi.
(7 marks)
(b)
The three ways are:
(i)
(ii)
(iii)
(c)
Invoice the goods in a strong currency such as the American Dollar or Euro since
a great depreciation of the currency is unusual hence Makwasa can be assured
of very little losses if any arising due to exchange rate movement.
Purchase a forward contract from a financial institution so that the foreign amount
that will be received from Mc Gregor will be exchanged for local currency at a
predetermined rate provided in the contract.
Purchase of an option with a financial institution to sell foreign currency received
from Mc Gregor at a predetermined rate. Makwasa will exercise the option to sell
the foreign currency if it becomes commercially viable to do so depending on
exchange rate movement.
(6
marks)
MK215m x 0.30
+ 0.4% (K36m+K29m+K41m+K38m+K52m)
8
10,000
= K64,500 + 0.4% x K196m
= K64,500 + K784,000
Answer = MK848,500.00
(7 marks)
Question 7.
(a)
Discuss three factors that would determine a countries exchange rate? (6 Marks)
Country’ monetary policy
Inflation rate
Balance of Payments
(b)
Explain how balance of payments would affect a country’s exchange rate? (4 Marks)
The balance of payment position of a country is a very important determinant of the
external value of its currency. Supply of foreign currency originates primarily from the
exports of goods and services and capital in flows, whereas demand for foreign
exchange originates from the payment for imports and the outflow of funds from the
country.
(c)
Mention the documents required by authorized dealer banks in order to approve
application to pay for imports? (10 Marks)
Authorised dealer approved proforma invoice
Suppliers final invoice or certificate of origin
The Malawi Customs and Exercise import bill of entry
Pre shipment inspection clean report of findings
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A bill of lading, airway bill or road / rail consignment note
Exchange control form E
Copy of import licence
Customs transit entry forms
Ex ware house home consumption entry form
The Malawi Customs and Excise Department receipt for all taxes
Question 8
(a)
What is export credit insurance and on what basis is the insurance premium calculated?
( 10 Marks)
Export credit insurance is a specialized insurance cover arranged in respect of risks
that exporters experience in the course of undertaking export trade in foreign
countries. The following risks are covered under export credit insurance cover;





Conflict risk
Insolvency risk
Transfer risk
Importation risk
Repudiation risk
The basis for the calculation of premium is the spread of risk arising from the nature of
the facility.
(b)
Describe the procedures and steps in the establishment of a documentary letter
of credit (5 marks)
A letter of credit is a banking mechanism which allows importers to offer
secure terms to exporters . All letters of credit contain the following
information:
1. A payment undertaking given by a bank on behalf of a buyer.
2. To pay a seller a given amount
3. On presentation of documents specified in the letter of credit
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4. Within a specified time limit
a. At a specified place
(C )
Describe two payment methods and list the advantages off such payment
methods to the exporter (5 Marks)
Clean Payments- open account or payment in advance. For payment in
advance exporter is paid before delivery of goods and therefore assumes no
risk
Documentary collections- exporter entrusts the handling of documents to
banks gives instructions concerning the release of the documents to the
importer. Documentary collections may be carried as sight collections or cash
against documents; or documents against acceptance. In documentary
collection it is less costly to the exporter and documents are not released to
the importer until payment has been effected.
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