Transnational or international commercial law refers to the set of rules, conventions, legislation as well as commercial customs or usage. International commercial law governs all commercial transactions which take place at international level. Transactions in which more than two countries are involved are known as international transaction. It is also termed as trade or business law because it also regulates the areas which are related with the business practices. Transnational commercial law governs contracts made by an organization, customer credit, house loan as well as other secured transactions (VerSteeg, 2015). The present report will develop the understanding about interest rate derivative and the role which they play in the global market. Besides this, it will also discuss the rules and regulations which are framed by European Union competition law. Further, the present law dissertation report will examine the various international payment methods which are available to Tina on the basis of case scenario. In addition to this, this project also helps in understand the international rules which are applied to such payment methods.
Functions of interest rate derivative and their role in the global economy
Interest rate derivative may be defined as a derivative tool which offers hedge to investors or bank in against to the changes in interest rates. Usually, investors undertake interest rate derivative as a speculative tool which helps them in generating huge amount of profit by making estimation about interest rate. By analyzing market trend or patter, investor can easily make profit through the appropriate estimation of interest rate changes. Interest rate derivative is the largest and growing derivative market in the world. According to the International swap and derivative association, 80% of the top companies make use of interest rate derivative to control their cash flows.
Interest rate swap is the most common type of interest rate derivative which provides hedge to investors in relation to interest rate fluctuations. Usually two parties are involved in interest rate derivatives (Mele, Obayashi and Shalen, 2015). In this, one party possesses fixed interest rate derivatives whereas another party has floating interest rate derivatives. In order to reduce the risk of interest rate fluctuations, party who is having the floating interest rate instrument makes exchange of their securities with the fixed interest rate instruments. Through this, party is able to hedge in against to the interest are fluctuations. Thus, in interest rate swap, two parties have to exchange their interest rate cash flows on the basis of specific notional amount. In this, one party move from fixed interest rate to floating interest rate whereas another party take decision to move from floating to fixed interest rate with the specific notional amount for the predetermined time period (Park, 2015). Through this, one counter party is able to make profit on the basis of his or her estimation. Whereas another secures himself with the risk of interest rate fluctuations who select fixed interest rate over the floating interest rate.
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For instance: There are two counter parties such as A and B, who are involved in interest rate derivative. In this, A has invested £50000 @ 8% fixed interest rate. Whereas B has invested his money in the market @ 8% floating interest rate. By analyzing the market trend, B threatened from the interest rate fluctuation which will take place in the near future. In contrary to this, A assumes that market will grow in the near future but he has invested his money in the fixed interest rate instrument. Thus, both the counter parties having similar principle or notional amount upon which they agree to exchange their interest rates. Besides this, both the parties want to exchange their cash flows through the financial intermediary such as bank. Thus, with the aim to increase profit margin and hedge, A and B have decided to exchange their cash flow for the period of 5 years. For such exchange of cash flows, bank charges exchange cost which also imposes financial cost in front of both the counter parties. In this, A receives floating rate and thereby paid fixed rate to B. On contrary to this, by exchanging the cash flows B receives fixed rate whereas make payment to B at floating rate. It enables A to increase his profitability aspects by taking risk. Whereas such interest swap have offered hedge to B in against to the risk of loss due to the interest rate fluctuations.
Functions of interest rate derivatives:
- Interest rate derivative provide hedging to the investors by protecting them from the interest rate fluctuations. It is hedging instrument that offers safe kind of return to investors. It offers fixed return to the counter party who selects fixed interest rate instrument over the floating rate instruments (Fernández, 2015). In this, both the parties exchange their interest rates without exchanging the underlying debt.
- Besides this, interest rate derivative is also the investment tool that provides opportunity to maximize their return by making investment in the floating rate instruments. Through this, individual is able to earn high profitability by undertaking the risk.
- Interest rate derivative also provides assistance to the organization in making control over their cash flows. By exchanging interest rate, company can easily assess their cash inflow and thereby able to make further investment decisions. Thus, interest rate swap also makes contribution in the growth and profitability of an organization.
Role of interest rate derivative in the context of global economy:
Interest rate derivatives play a vital role in the development of global economy. In the present scenario, investors prefer to make use of derivatives on a large basis or scale (Russo and Fabozzi, 2016). This aspect facilitates high level of market efficiency through hedging, leveraging and substitutability. All these three aspects encourage investors to make profit by reducing the risk aspect and thereby make contribution in the growth of global economy. Hedging provide assistance to investors to transfer their risk of the underlying asset from buying agent to the selling agent. In addition to this, derivative market also facilitates arbitration between the two different types of asset. Interest rate derivative places positive impact upon economy because it helps investor in distributing the risk through hedging. In addition to this, lower cost of capital also attract agent to make focus upon their strengths and thereby make contribution in sustain the growth aspect. In the dynamic business environment there are high levels of uncertainty in relation to the fluctuation of interest rate which will take place in global economy (Chang, Chen and Zhu, 2015). Derivative instrument or interest rate derivative provides hedge to individual investor in against to inflation and deflation. Derivative instruments provide help in discovering the price of asset and thereby help in managing the risk more effectively or efficiently.
EU competition law:
Completion laws and legislation which is framed by European Union helps in restricting the unethical practices which may develop unhealthy competition at marketplace. According to European Union competition law there will be no collusion between the competitors in the interest rate derivative market. If any collusion seen in the competitors then it is considered as violation as per EU competition law. During the Euro interest rate derivatives and yen interest rate derivatives bank traders had shared every information with each other. They had consulted their negotiation and pricing strategies and there by become the part of illegal cartel (VerSteeg, 2015). By taking into consideration such aspect European Union had framed the rule that bank as an enterprise is responsible for the each and every act of their employees or bank traders. In addition to this, European Union had also declared the punishment system for the banks who will participate in any illegal cartel. In 2013, 8 banks charged with the monetary punishment of Eur 171 billion because they had participated in illegal cartel in the market of interest rate derivatives. Besides this, EU competition law provides support to banks that they also make the discussion in relation to their bank rate figures with the aim to calculate EURIBOR. It also helps other banks in framing the competent trading and pricing strategies. It is considered as immunity for banks because they are free to discuss their pricing policies with other banks. In this situation, law will not charge any fine from bank foe such kind of practices. Thus, commission leniency policy provides support to bank and there by helps them in framing suitable trading or pricing strategies.
There are specifically two types of anti competitive activity which banks require to avoid in order complying with EU legislation. It is strictly prohibited for bank to make any anti-competitive agreements. Both UK and EU competition law have prohibited agreements, arrangements and other business practices which having adverse impact upon the trade aspects of UK and EU. In addition to this, bank does have the right to make abuse of their dominant position in the financial market (Mele, Obayashi and Shalen, 2015). Thus, all the banks are required to avoid such unethical practices in the financial market. If any bank does not complying with such legislation then they have to face serious consequences of breach which are enumerated below:
- If any bank or company beaches the EU competition rule then have to pay fine up to the 10% of their global turnover.
- In addition to this, banks or other companies are obliged to give compensation to other customers or competitors. Bank has the liability to compensate the damaged party which is occurred due to the anti competitive behavior of them.
Any person who make illegal benefit from their position then they are disqualified from the position of company director or else.
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According to EU legislation there is no high level of exemption is provided to the companies or bank that behaved unethically or made any anti competitive agreements. On the basis of the rules and regulation of European Union if defendant party is able to justifying the reason due to which they have made anti competitive agreements. For example: Bank refused to his one of the customer in relation to the supply of financial instruments or asset due to their poor credit rating. Bank had made such decision to protect their interest or business. In this situation, banks are exempted to pay fine for such activity. On the basis of European Union laws and legislation when bank do such activity out of their business interest then it is recognized as an abuse of position. In the case unethical behavior or activity bank is charged with fine which up to the 10% of their global turnover.
On the basis of all the above mentioned laws and legislation which is framed by European Union provides support to bank. In addition to this, it also provide platform to banks to make transaction with each other. Further, they also have opportunity to discuss their trade policies and strategies with each other. On the basis of such laws and legislation banks are able to make transaction with each other. Usually banks make huge amount of investment in the securities in which they wishes to invest. Nevertheless, they do not have any platform for making such transactions at the very cost effective rates (Competition law - the basics, 2016). In this situation, inter bank transactions provide assistance to make investment in the interest rate derivative as per their requirement. Through this, they are able to exchange their cash flows at international level.
For instance: RBS which the international bank having 5 million @9% fixed interest rate derivatives. On other hand, UBS having 5 million floating interest rate derivatives. By making analysis of the market trend RBS have identified that market will grow in near future. On the basis of this aspect RBS wishes to make investment in floating interest rate derivative instrument. As per the interbank financial arrangements RBS can exchange their interest rate cash flow with UBS who possess 5 million floating interest rate derivative. Through this, UBS is able to exchange their interest rate cash flow with another bank at the very reasonable cost. It enables bank to improve their profitability and hedge the investment from interest rate fluctuations which take place in market. Thus, interbank interest rate derivative arrangements provide support to banks in relation to the exchange of cash flows at the very cost effective charges.
Stating the various international payment methods which are available to Tina for the international trade or transaction
International payment refers to the transfer of money from one country to another country for the trade which is made by them. Each company imports some product or services which are not available in their country. In addition to this, they also export the product which are available in excess of their country. For such import and export respective countries requires making payment to another country by the means of various payment mode such as letter of credit, cashing in advance etc. On the basis of the cited case scenario Tina exports the children toys to the different large and small companies which are situated around the world. Usually, she sends her good with the invoices and there by prefers to get payment within the 14 days. Now, most of the purchaser makes default in payment due to their insolvency. On the basis of this aspect Tina needs to properly structure their transaction to prevent the risk of non-payment (Chance and Brooks, 2015). Thus, there are several international payment methods or ways which are available to Tina. It includes letter of credit, cash in advance, documentary collection, opening account and international consignment. All these methods having different types of risk which closely affects the certainty of payment. Thus, by making assessment of risks which are associated with different payment methods Tina can opt the best method which prevents the risk of non-payment. Various international payment methods which are available to Tina are enumerated below:
Cash in advance: Exporter can reduce the payment risk by taking resort of cash in advance method. Exporter can prevent the risk of default by taking cash in advance for the goods or serviced which they going to export. Through thus, exporter is able to get money before transferring the title of the goods. It is highly secured way which mitigate the risk of non- payment. In this, exporter is also secured from the insolvency aspect of the importer. If importer becomes insolvent in near future then exporter will not face difficulty in relation to payment (Bénétrix, Lane and Shambaugh, 2015). Thus, it is the most effective way which protects exporter from the risk of payment. Technological advancement also supports such method. With the help of internet exporter can easily get advance payment within few seconds or minutes. Nevertheless, importer hesitates to make payment in advance for the good because it creates financial burden in front of them. Usually, importer prefers to make payment within certain time duration and there mitigate the situation of unfavorable cash flows. Thus, importer creates difficulty in front of exporter in relation to the adoption of cash in advance method (Chiang and et.al, 2015). Nevertheless, it is the most effective mean of international payment which gives assurance to exporter about payment.
Letter of credit: it is another most effective method which ensures exporter that will receive payment for the goods which are exported by them. Letter of credit also provides security to exporter in relation to payment from importer. In letter of credit buyer's bank give guarantee to exporter on the behalf of importer if they make default in payment. Usually, it is not possible for exporter to assess the creditworthiness of the foreign buyer. Whereas exporter have idea about the creditworthiness of the buyer bank. Through letter of credit buyer’s bank give assurance that they will make payment to exporter if importer makes any default in payment. It provides assistance to exporter to reduce the risk of default and thereby get payment for goods which are shipped by them (Schmidt and Hewig, 2015). Through this, they are able to get payment within the suitable time frame.
Documentary collections: Documentary letter of credit or draft offers protection to importer and exporter. Importer think that if they made cash payment in advance then there is no guaranteeing that exporter will ship the goods. In addition this, exporter have also confusion that importer will make payment for the goods on time or not. In this, importer give documentary letter of credit to exporter which contains the days within which importer will make payment to them. In addition to this, it also contains the bank name that makes payment to exporter on the presentment of documents or letter of credit. Documentary collections are less expensive to the letter of credit (Bogoch and et.al, 2015). Thus, by presenting the documentary letter of credit to the concerned bank exporter can receive money for the goods which are shipped by them. For providing such service bank charges some cost from the importer. On the basis of all the above mentioned aspect documentary collection provides helps in getting payment of the shipment on time.
Opening account: it is also the more convenient method which provides relief to the importer. Nevertheless, it is unsecured from the side of exporter. In open account exporter give bills to importer which contains the amount and time limit such as 30, 60 and 90 days. Usually, exporter is ready to open the account of importer to whom they have strong relationship. In addition to this, export also prefers to open the account of importer who has well established business and high creditworthiness. On the basis of such account importer has liability to pay agreed amount on predetermined date. It imposes high level of risk in front of exporter in relation to payment (Armani and et.al, 2015). Moreover, there is absence of bank, document and other legal channels in open account. Due to this aspect exporter having no legal grantee in regarding to the payment of goods which are shipped by them.
Consignment: international consignment sale is also one of the method which helps in international payment. In this, exporter shipped the good to distributor of overseas market. In this condition, exporter retains the title of goods with itself unless the goods are sold by the distributor. Once good is sold by the distributor then payment is transferred by him in account of exporter (Jovanović, 2015). Nevertheless, there is no guarantee that distributor of overseas market make payment to the exporter for the goods sold by them. Thus, it is highly unsecured way of international payment (Export Import Payment Terms, 2016).
Letters of credit
Cash in advance
On the basis of all pros and cons of international payment method it is advised to Tina that she needs to undertake letter of credit and cash in advance method. Both these methods helps exporter by mitigating the risk of non-payment. As per the cited case scenario Tina who exports toys to the other part of world facing problem of non-payment from large number of her customers. In order to remove such issue Tina needs to receive cash in advance from her customers who are ready to give payment from they will receive. Through this, Tina is able to protect herself with the insolvency aspect of their customers. It is the most effective way which gives assurance to exporter in relation to their payment.
In addition this, Tina can also undertake the letter of credit for their customers who are not ready to pay in advance. Usually, customer or importer prefers to take some time for making payment. In this situation, letter of credit payment system proves to be more fruitful for the exporter. Letter of credit is also one of the secured payment method which helps them in reducing the risk of non- payment. In this, buyer's bank gives assurance in relation to the payment of shipped good if buyer makes default in payment. In addition to this, it is very easy for Tina to assess the creditworthiness of respective bank who issue letter of credit to buyer. Through this, Tina is able to protect the amount of the shipped goods and there able to achieve success in the dynamic business arena.
From this project report it has been concluded that interest rate derivative or swap is most effective financial instrument. It offer hedge to investors from the interest rate fluctuations. It can be seen in the report that by exchanging interest rate cash flows counter parties are able to mitigate the risk of interest rate fluctuations. Besides this, it can be inferred that Tina needs to make assessment of all the methods before the selection of gateway for international payment. Further, it can be concluded that Tina should adopt cash in advance and letter of credit method which ensures exporter that they receive payment for the shipped toys within the suitable time period without any default.
Books and Journals
- Armani, A. and et.al, 2015. DNA and Mini-DNA barcoding for the identification of Porgies species (family Sparidae) of commercial interest on the international market. Food Control.
- Bénétrix, A.S., Lane, P.R. and Shambaugh, J.C., 2015. International currency exposures, valuation effects and the global financial crisis. Journal of International Economics.
- Bogoch, I.I. and et.al., 2015. Assessment of the potential for international dissemination of Ebola virus via commercial air travel during the 2014 west African outbreak. The Lancet.
- Chance, D. and Brooks, R., 2015. Introduction to derivatives and risk management. Cengage Learning.
- Chang, L., Chen, S. and Zhu, A., 2015. Properties of the Cox–Ingersoll–Ross Interest Rate Processes with Two-sided Reflections. Communications in Statistics-Theory and Methods.