Country Rating - CME Australian Dollar - Encyclopedic Dictionary

CME Australian Dollar

B. Country Rating

An assessment of the overall political and economic stability of a country in which a bank is domiciled.

C Company is inherently a sound credit with no serious deficiencies, but financials reveal at least one fundamental area of concern that prevents a higher rating. The company may recently have experienced a period of difficulty, but those pressures should not be long term in nature. The company’s ability to absorb a surprise, however, is less than that for organizations with better operating records.

C/D While still considered an acceptable credit, the company has some meaningful deficiencies. Its ability to deal with further deterioration is less than that for better-rated companies.

D The company’s financials suggest obvious weaknesseses, most likely created by asset quality considerations and/or a poorly structured balance sheet. A meaningful level of uncertainty and vulnerability exists going forward. The ability to address further unexpected problems must be questioned.

D/E The company has areas of major weaknesses which may include funding/liquidity difficulties. A high degree of uncertainty exists as to the company’s ability to absorb incremental problems.

E Very serious problems exist for the company, creating doubt as to its continued viability without some form of outside assistance—regulatory or otherwise.

QR-A Exceptionally strong company as evidenced by its recent financial statements and its historical record.

QR-B Statistically a very sound institution. Financials reveal no abnormal lending or funding practices, while profitability, capital adequacy, and asset quality indicators consistently rank above peer group standards.

QR-C Statistical credentials should be viewed as average relative to peer group norms.

A sound credit with one or more concerns preventing a higher rating.

QR-D The company’s financial performance has typically fallen below average parameters established by its peers. Existing earnings weakness, exposure to margin contraction, asset quality concerns, and/or aggressive management of loan growth raise serious questions.

QR-E Several problems of a serious nature exist. Key financial indicators and/or abnormal growth patterns suggest significant uncertainty over the near term. The institution may well be under special regulatory supervision, and its continued viability with outside assistance may be at issue.

I. An industrialized country with a long history of political stability complemented by an overall sound financial condition. The country must have demonstrated the ability to access capital markets throughout the world on favorable terms.

II. An industrialized country which has had a history of political and economic stability but is experiencing some current political unrest or significant economic difficulties.

It enjoys continued ability to access capital markets worldwide but at increasingly higher margins. In the short run, the risk of default is minimal.

III. An industrialized or developing country with a wealth of resources, which may have difficulty servicing its external debt as a result of political and/or economic problems.

Although it has access to capial markets worldwide, this cannot be assured in the future.

KEEFE’S DOMESTIC AND FOREIGN BANK RATINGS

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KNOCKOUT OPTION

Also known as barrier option, a knockout option is an option that is canceled (i.e., knocked out) if the exchange rate crosses, even momentarily, a predefined level called the outstrike. If the exchange rate breaks this barrier, the holder cannot exercise this option, even though it ends up in-the-money. This type of option is obviously less expensive than the standard option because of this risk of early termination.

KORUNA

Monetary unit of Czechoslovakia.

KRONA

Monetary unit of Iceland and Sweden.

KRONE

Monetary unit of Denmark and Norway.

KWACHA

Monetary unit of Angola.

KYAT

Monetary unit of Burma.

IV. A developing country which is currently facing extreme difficulty in raising external capital at all maturity levels.

V. A country which has defaulted on its external debt payments or which is in a position where a default is highly probable.

KYAT

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L

LABEL OF CONSUMER CONFIDENCE

This label was displayed in shop windows and in advertising during the transition period for the euro between January 1, 1999 and January 1, 2001, to inform customers that the prices of the products or services are displayed in both euro and national currency units.

See also LEADING AND LAGGING.

LAMBDA

See CURRENCY OPTION PRICING SENSITIVITY.

LAW OF ONE PRICE

See PURCHASING POWER PARITY.

LEADING AND LAGGING

Leading and lagging are important risk-reduction techniques for a wide variety of working capital problems of MNCs. In many situations, forward and money-market hedges are not available to eliminate currency risk. Under such circumstances, MNCs can reduce their foreign exchange exposure by leading and lagging payables and receivables, that is, paying early or late. Leading is accelerating, rather than delaying (lagging). This can be accomplished by accelerating payments from soft-currency to hard-currency countries and by delaying inflows from hard-currency to soft-currency countries. Leading and lagging can be used most easily between affiliates of the same company, but the technique can also be used with independent firms. Most governments impose certain limits on leads and lags, since it has the effect of putting pressures on a weak currency. For example, some governments set 180 days as a limit for receiving payments for exports or making payment for imports. When the MNC makes use of leads and lags, it must adjust the performance measures of its subsidiaries and managers that are cooperating in the endeavor. The leads and lags can distort the profitability of individual divisions.

See also BALANCE SHEET HEDGING; CURRENCY RISK MANAGEMENT; FOREIGN EXCHANGE HEDGING; FORWARD MARKET HEDGE; MONEY-MARKET HEDGE.

LETTERS OF CREDIT

A letter of credit (L/C) is a credit letter normally issued by the buyer’s bank in which the bank promises to pay money up to a stated amount for a specified period for merchandise when delivered. It substitutes the bank’s credit for the importer’s and eliminates the exporter’s risk. It is used in international trade. The letter of credit (L/C) can be revocable or irrevocable.

A revocable L/C is a means of arranging payment, but it does not guarantee payment. It can

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be altered or revoked, without notice, at any time up to the time a draft is presented to the issuing bank. An irrevocable L/C, on the other hand, cannot be revoked without the special permission of all parties concerned, including the exporter. A letter of credit can also be confirmed or unconfirmed. A confirmed L/C is an L/C issued by one bank and confirmed by another, obligating both banks to honor any drafts drawn in compliance. For example, “we hereby confirm this credit and undertake to pay drafts drawn in accordance with the terms and conditions of the letter of credit.” An unconfirmed L/C is the obligation of only the issuing bank. The three main types of letters of credit, in order of safety for the exporter, are (1) the irrevocable, confirmed L/C; (2) the irrevocable, unconfirmed L/C; and (3) the revocable L/C.

A summary of the terms and arrangements concerning these three types of L/Cs is shown in Exhibit 77.

There are also other types of letters of credit:

• Letter of credit (Cumulative)—A revolving letter of credit which permits any amount not used during any of the specified periods to be carried over and added to the amounts available in subsequent periods.

• Letter of credit (Non-Cumulative)—A revolving letter of credit which prohibits the amount not used during the specific period to be available in the subsequent periods.

• Letter of credit (Deferred Payment)—A letter of credit issued for the purchase and financing of merchandise, similar to acceptance letter of credit, except that it requires presentation of sight drafts which are payable on installment basis usually for periods of 1 year or more. Under this type of credit, the seller is financing the buyer until the stipulated time his drafts can be presented to the bank for payment. There is a significant difference in the bank’s commitment, depending on whether the negotiating bank advised or confirmed the letter of credit.

• Letter of credit (McLean)—A letter of credit which requires the beneficiary to present only a draft or a receipt for specified funds before he receives payment.

• Letter of credit (Negotiable)—A letter of credit issued in such form that it allows any bank to negotiate the documents. Negotiable credits incorporate the opening bank’s engagement, stating that the drafts will be duly honored on presentation, provided they comply with all terms of the credit. A negotiable letter of credit says specifically that the “Drafts must be negotiated or presented to the drawee not later

EXHIBIT 77

Arrangements in Different Letters of Credit

Irrevocable Confirmed L/C

Irrevocable

Unconfirmed L/C Revocable L/C

Who applies for Importer Importer Importer

Who is obligated to pay

Issuing bank and confirming bank

Issuing bank None

Who applies for amendment

Importer Importer Importer

Who approves amendment

Issuing bank, exporter, and confirming bank

Issuing bank and exporter

Issuing bank Who reimburses

paying bank

Issuing bank Issuing bank Issuing bank

Who reimburses issuing bank

Importer Importer Importer

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than….” In contrast, the straight letter of credit does not mention the word nego- tiated.

• Letter of credit (Revolving)—A credit which includes a provision for reinstating its face value after being drawn within a stated period of time. This kind of credit facilitates the financing of ongoing regular purchases.

• Letter of credit (Standby)—One issued for the express purpose of effecting payment in the event of default. The issuing bank is prepared to pay but does not expect to as long as the underlying transaction is properly fulfilled.

• Letter of credit (Traveler’s)—A letter of credit which is issued by a bank to a customer preparing for an extended trip. The customer pays for the letter of credit at the time of issuance, and a bank issues the letter for a specified period of time in the amount purchased. The bank furnishes a list of correspondent banks where drafts against the letter of credit will be honored. The bank also identifies the customer by exhibiting a specimen signature of the purchaser in the folder enclosing the list of correspondent banks. Each bank, which honors a draft, endorses on the letter of credit the date when a payment was made, the bank’s name, and the amount drawn against the letter of credit and charges the issuing bank’s account.

The steps involved in a letter of credit transaction are summarized in Exhibit 78.

See also CONFIRMED LETTER OF CREDIT; DOCUMENTARY LETTER OF CREDIT;

DRAFT; IRREVOCABLE LETTER OF CREDIT; NONDOCUMENTARY LETTER OF CREDIT; REVOCABLE LETTER OF CREDIT; REVOLVING LETTER OF CREDIT;

TRADE CREDIT INSTRUMENTS; TRANSFERABLE LETTER OF CREDIT; UNCON- FIRMED LETTER OF CREDIT.

EXHIBIT 78

Steps in a Letter of Credit Transaction

Step 2:

Letter of credit Step 5:

Pound sterling Step 1:

Application of letter of credit Step 4:

Letter of credit and documentation

United States Step 3: Goods shipped

Great Britain

Step 6: Draft and documentation English

exporter

English negotiation bank

Importer’s American bank

American importer LETTERS OF CREDIT

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LIABILITY MANAGEMENT OF BANKS

Traditionally, banks have taken the liability side of the balance sheet pretty much as outside of their control in the short run. They have taken liabilities as given and have been concerned with asset management. Liability management involves actions taken by banks and other depositary institutions to actively obtain funds at their own initiative by issuing negotiable certificates of deposit (CDs), by borrowing federal funds, and by using other procedures. It means altering the bank’s liability structure (mix of demand deposits, time deposits, etc.) by changing the interest paid on nontransaction liabilities (such as CDs). The technique of liability management is certainly an important discretionary source of bank funds. However, the excessive use of the technique would make them vulnerable in future liquidity crises.