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PART-A:INTERNATIONAL TRADE

INTERNATIONAL BUSINESS METHODS:


The most common methods of international business
are as follows:
a)International Trade
b)Licensing
c)Franchising
d)Joint Ventures
e)Acquisition of existing business
f)Establishing new foreign subsidiaries.
INTERNATIONAL TRADE: It is simple import &
exports i.e. buy at lower rate & sell at high
rate.
LICENSING:
A company can give technology (copy right,
patents, trade mark& trade name etc). in exchange
of certain fee.

FRANCHISING:
It is a very popular form of SME these days like
KFC, Pizza Hut etc.
It is defined as a continuing arrangement between
the parent company i.e. franchisor and an
entrepreneur i.e. franchisee. The agreement is for
a certain period which can be extended as decided
mutually.
ADVANTAGES:
To the franchisor

To the franchisee

Expand distribution
without increased capital
investment.
Community acceptance of
the product
Marketing & distribution
expanses are shared.
Some operating cost may
be transferred to the
franchisee.
Flat fee can be collected
from franchisee
Through agreement,
quality control can be
maintained.
Percentage on sale can be
earned.

Sound management,
training and decision
making may be available.
Market tested product so
less risk will be there.
Advertising & promotion
is already there.
Acceptance in large
system of retailers.
Credit may be available.
Advisory available.
Credit may be available.

DISADVANTAGES:
Franchisor
Long distance control
over franchisee.
Expanses on training
sometimes very high.
Loss of some ownership
Product can be stolen

Franchisee
Gives up much freedom in
management decision.
Profits are always
shared.
Franchises may be very
expensive.
Undue interference.

Success depends on wise planning & its results.


The agreement may include energy, money, ideas,
location, experience, training, management, name,
know-how etc.
DIFFERNET TYPE OF FRANCISES:
1-Straight product distribution i.e. only product
is provided in salable form like general store
products.

2-Product license franchises: Only name is used but


product is manufactured as per specifications of
the franchisor.
3-Trade name franchise: Trade name is given but no
control over product or service.
JOINT VENTURES:
Jointly operated & owned by two or more entities
like General Mill & NESTLE for cereals. It helps to
penetrate the foreign market.
Existing business:
Such a business has a track record so can be run
more easily sometimes.
So advantages are as follows:
The business is operating & success can be
judged.
Customers are known & feedback is easy.
Financial data is available for inspection.
Business activity can be verified
Bankers etc have an impression of business.
Competitors know the business.
While purchasing an existing business following
points are required to be considered.

Financial picture
Why for sale, is it TITANIC?
What are business trends?
Books should be checked.
All concerned should be interviewed.

START UP OR PURCHASE A FRANCHISE:


All franchises have tested programs so consider the
following while purchasing::

Proven operational methods as part of package.


Research is available.
Training can be provided to entrepreneur.
Name & reputation
Risks are minimized.

LETTER OF CREDIT, THE SPIRIT OF INTERNATIONAL TRADE


International trade demands a flow of goods from
seller to buyer and of payment from buyer to
seller. The goods movement may be evidenced by
appropriate
documents.
Payment,
however,
is
influenced by trust between the commercial parties,
their
need
for
finance
and,
possibly,
by
governmental
trade
and
exchange
control
regulations.
Consequently, the documentary credit is frequently
the method of payment. The buyers bank pays the
seller against presentation of documents and
compliance with conditions stipulated by the buyer.
A world-wide use, with an immense daily turnover in
transactions and value, necessitates a universal
standard of practice. The International Chamber of
Commerce (ICC) provides this with its Uniform and
Practice for Documentary Credits(UCP), but their
effectiveness is reduced unless the commercial
parties and the banks involved understand the
basics of the operations.
BUT WHAT IMF SAYS:

Pakistan obtained US$ 11.3B in 2008 from IMF & so


far US$ 8.3B has been released. When IMF released
US$ 3.1B we paid US$ 3.65B to various institutions
in the same period. The foreign debt is at US$ 55B
which is estimated to increase to US$ 72.6B in
2015-16.
POSSIBLE PROBLEMS
The seller says,
We want to be certain that the buyer is able to
pay on time once the goods have been shipped. How
can we minimize risk of non-payment?
The buyer says,
We do not know the seller can we be sure that he
will deliver on time?
The seller worries,
We are supplying the buyer with goods that
ourselves have bought from a sub-contractor.

we

How can we prevent the buyer from finding out and


contacting our supplier directly?
The buyer thinks,
Before we pay, how can we check that the goods are
exactly those we ordered?
BOTH THE PARTIES WANT:
"How can the banks help us in the practical
arrangements for these transactions, specially

by
assisting
us
documentation?

with

all

the

necessary

Additional services desired:


We would prefer to delay paying for the goods
until we have sold them. Will our bank provide
credit for the intervening period?
Where
can
we
get
information
on
currency
restrictions, and import or export licenses?

What the seller wants


Contract Fulfillment
Assurance that he will be paid in full within the
agreed time limit.
Convenience
The convenience of receiving payment at his own
bank or through a bank in his own country.
Prompt Payment
Prompt payment for the sale of the goods, so as to
improve the liquidity of his business.
Advice
The knowledge necessary to conduct complex trade
transactions.
What the buyer wants
Contract Fulfillment

Assurance that he does not have to pay the seller


until he is certain that the seller has fulfilled
his obligations correctly.
Convenience
The convenience of using an intervening third party
in whom both buyer and seller have confidence-such
as a bank with its documentary expertise-when
making payment.
Credit
A
managed
cash-flow,
obtaining bank finance.

by

the

possibility

of

Expert assistance
Expert assistance and facilities in dealing with
often complex transactions, particularly with the
specific procedures to be followed.

TIME FOR PAYMENT


SELLER
In advance
He needs payment before shipment, as he cannot
otherwise finance production of the goods the buyer
has ordered.
At time of Shipment
He wants assurance of payment as soon as the goods
are shipped.
He has to meet regulations stipulating payment at
time of shipment rather than before or after it.
After shipment
He is prepared to wait for payment for a certain
time after shipment, as he trusts the buyer and
appreciates his position.
BUYER
In advance
He trusts the seller, knowing that the contract
will be carried out as agreed, and he is therefore
prepared to pay in advance.
At time of Shipment
He does not want to take the risk of paying before
being certain that the goods are shipped on time
and that they are as stipulated in his contract
with the seller.

He has to meet regulations stipulating payment at


time of shipment rather than before or after it.
After shipment
He possibly wants to sell the goods before he pays
the seller.

DOCUMENTARY CREDITS
Definition
In simple terms, a documentary credit/letter
credit is a conditional bank undertaking
payment.

of
of

Expressed more fully, it is a written undertaking


by a bank (issuing bank) given to the seller
(beneficiary)
at
the
request,
and
on
the
instructions, of the buyer (applicant) to pay at
sight or at a determinable future date up to a
stated sum of money, within a prescribed time limit
and against stipulated documents.
These stipulated documents are likely to include
those
required
for
commercial,
regulatory,
insurance,
or
transport
purposes,
such
as
commercial
invoice,
certificate
of
origin,
insurance policy or certificate, and a transport
document of a type appropriate to the mode(s) of
transport used.
Documentary credits offer both parties to a
transaction a degree of security, combined with a
possibility, for a creditworthy party, of securing
financial assistance more easily.
Buyer
Because the documentary credit is a conditional
undertaking, payment is, of course, made on behalf
of the buyer against documents which may represent
the goods and give him rights in them.
However, according to arrangements made between him
and the bank-and, in some cases, by reason of local
laws or regulations-he may have to make an advance

deposit at the time of requesting the issuance of


the credit, or he may be required to place the
issuing bank in funds at the time documents are
presented to the overseas banking correspondent of
the issuing bank.
Seller
Because
the
documentary
credit
is
a
bank
undertaking, the seller can look to the bank for
payment, instead of relaying upon the ability or
willingness of the buyer to pay subject to
fulfillment of certain terms and conditions.
ISSUING A CREDIT
The buyer and the seller conclude a sales contract
providing for payment by documentary credit.
The buyer instructs his bank-the issuing bank-to
issue
a
credit
in
favour
of
the
seller
(beneficiary).
The advising or confirming bank informs the seller
that the credit has been issued.
The issuing bank asks another bank, usually in the
country of the seller, to advise or confirm the
credit.
Advising/ confirming bank
There are usually two banks involved in a
documentary credit operation. The issuing bank is
the bank of the buyer. The second bank, the
advising bank, is usually a bank in the sellers
country.

The second bank can be simply an advising bank, or


it can also assume the more important role of a
confirming bank.
In either case, it undertakes the transmission of
the credit. Article 8 (UCP) requires the advising
bank to take reasonable care to check the apparent
authenticity of the credit which it advises.

Issuing bank
If the second bank is simply advising the credit,
it will mention this fact when it forwards the
credit to the seller. Such a bank is under no
commitment to make payment to the seller, even
though it may be nominated in the credit as the
bank authorized to pay, to accept drafts, or to
negotiate.
If the advising bank is also confirming the
credit, it will so state. This means that the
confirming
bank,
regardless
of
any
other
consideration, must pay, accept, or negotiate
without recourse to the seller, provided all the
documents are in order and the credit requirements
are met.
SOME IMPORTANT RELEVANT SCHEDULE OF BANK CHARGES
IMPORTS:
Sr.#

2
3
4

Annual

Quarterly
Minimum
amoun
payme
payme
t
nt
nt
for
one
LC
Upto Rs.25M 0.40% per
Rs.1,400
quart
or
er
negot
iable
Upto Rs.50M 0.35% per
quart
er
Upto
0.29% per
Rs.10
quart
0M
er
Above
Negotiable

LC

Negotiable

LC advising

Rs.1,400
per
quar
ter
Rs.1,200

LC advising
amend
ment
LC
Minimum
confi
Rs.1
rmati
,400
on

amend
ment
& handling
charg
es
One off
Normal mark
trans
up
actio
rate
n
Documents
No
retir
commi
ed
ssion
with
10
days
If retired
From 0.29%
durin
to
g 15
0.46%
days
i.e.
or
negot
more
iable

EXPORTS:

WHERE WE STAND PRESENTLY:


INDICATORS

JULY-SEPT,11

JULY-SEPT 10

GDP GROWTH
FISCAL DEFICIT
RS.VS $
IMPORTS
EXPORTS
TRADE GAP
CURRENT A/c
DEFICIT

2.5%-2.8%
1.5% OF GDP
Rs.86.12
$9B
$5B
$3.85B
$545M

4.1%
1.6% OF GDP
Rs.83.12
$7.6B
$4.3B
$3.15B
587M

HOME REMITTANCE
FOREIGN
INVESTMEN
T
FOREX RESERVES
EXTERNAL DEBT
EXTERNAL DEBT
SERVICING

$2.6B
$455M

$2.3B
$636M

$17B
$55.6B
$5.7B

$14.4B
$52.3B
$5.3B

The Government borrowings are increasing and in


2010-11 so far Rs.198B has been borrowed due
to floods etc.

PAK RS.VS USD SINCE APRIL 2008


The rupee has shed 37% i.e. from Rs.62.57 in
April 2008 to Rs.87 in October 2010 in the
present Government period due to following
reasons:
Losing investors confidence on the current
Political system.

Global recession.
Flight of capital due to judicial crisis.
Law and order situation after Benazirs
Assassination.
IMF condition to make oil/POL payments
through open market in stead of SBP.
High oil & food import prices.
$11.7B loan of IMF.
Freezing of forex exchange companies.
$ =Rs.19.32 in 1989.
IMF Support Arrangements to Pakistan
(1980-2004)
Date of Amou
Disbursem
Arrangem nt
Signed
Arrangem
ent
ent
(SDR
during
ent
(SDR
(expiration millio
rule of
million)
)
n)

EFF

24-11-80 1268.0
(23-11-83) 0
SBA
28-12-88 273.15
(7-3-90)
SAF
28-12-88 382.41
(27-12-91)
SBA
16-9-93 265.40
EFF/
(15-9-94) 379.10
ESAF
22-2-94 606.60
(21-2-97)
22-2-94
(21-2-97)
SBA
13-12-95 562.59
(31-3-97)
EFF/ESA 20-10-97 454.92
F
(19-10- 682.38
2000)
SBA
29-11- 465.00
2000
(30-92001)
PRGF
7-12-2001 1033.7
(5-120
2004)

1079.00 Ziaul
Haq
194.48 Benazir
Bhutto
382.41 Benazir
Bhutto
88.00 Nawaz
123.20 Sharif
172.20

294.69 Benazir
Bhutto
113.75 Nawaz
265.37 Sharif
465.00 Pervez
Musharr
af
861.42 Pervez
Musharr
af

LATEST LOAN:
Stand-By Arrangement (SBA) 2008-10
Main Features
a) Pakistan submitted to the IMF a Request for
Stand-By Arrangement on 20
November, 2008 amounting SDR 5.17 billion
($ 7.6 billion) equal to 500%
of Pakistan's quota in the Fund. It has
increased to $11.7B. Pakistan has
requested to extend it upto 31-12-10 as it was
expired on 30-09-10.
b) The Arrangement is for a period of 23
months.
c) It is on interest rate of 3.51-4.51%. The
amount will be disbursed in seven
tranches - the first tranche of SDR 2.067
billion has been received on 29
November, 2008 and the balance amount will
be disbursed in six quarterly

instalments during 2009-10. The amount and


interest will be repaid in five
Years from 2011.
Objective and Economic Program (2009-2010):
The main objectives of the Arrangement are to
(i)

restore confidence of domestic and


external
investors
by
addressing
macroeconomic imbalances through a
tightening of fiscal and monetary policies;
and
ii) protect the poor and preserve social stability
through a well-targeted and adequately funded
social safety net. For this purpose the
government of Pakistan has initiated an
Economic Program covering 24 months. The
main elements of the Program are:
Reduce fiscal deficit: 7.4% of GDP in 2008
to 4.2% in 2009 and 3.3% in 2010
Tighten monetary policy (increase interest
rate, eliminate government borrowing) to
reduce inflation to 6% in 2010

Increase expenditure on social safety net


(0.6% of GDP to 0.9% in 2009) -work with
World Bank to prepare a comprehensive
program of safety net
Conditionality of SBA.
OTHER MAIN POINTS:
a) The program is subject to quarterly review
and performance criteria. The
conditionality covers actions prior to the
approval of arrangement by the IMF
Board, performance criteria, benchmarks
and quantitative targets.
b) The prior actions included increasing the
State Bank's discount rate from 13%
to15% as a measure to control inflation.
c)
Raise in electricity tariff by an average
of 18% effective from 5 September, 2008.
Evaluation of SBA 2008-10.
The IMF arrangements can be seen from
different perspectives i.e.

It may refer to the following:


- Bail-out package.
- Investors' confidence builder.
- Economic stabilizer and revival of growth.
- Step towards greater external dependence and
source of hardship to the
people, and so on.
- Ignores protecting the poor.
-Presumes that tight monetary and fiscal policies
will ensure economic revival in later years.
-Reduced government borrowings
This scenario is based on the premise that the
government will be able to take fiscal and
monetary measures as stipulated in the
Arrangement.
Table
Economic Indicators
2008
2009
2010
GDP
5.8
3.4
5.0
growth rate
%
CPI (end
21.5
20.0
6.0
year) %

Gross
12.9
national
savings (%
GDP)
Gross
21.3
capital
formation
(% GDP)
External
8.4
resources(%
GDP)
Fiscal
7.4
deficit (%
GDP)
Debt (%
57.9
GDP)
Current
8.4
Account
deficit (%
GDP)
External
26.5
debt (%
GDP)
Reserves ($ 8.591

13.5

15.7

20.0

21.3

6.5

5.6

4.2

3.3

54.6

52.4

6.5

5.7

31.4

33.2

8.591

11,291

million)

CREDIT APPLICATION
The instructions to be given by the applicant to
the issuing bank will cover such items as.
1. The full (and correct) name and address of the
beneficiary (seller).
2. The amount of the credit.
3. The type of credit, whether
*
revocable
*
irrevocable
*
irrevocable,
with
the
added
confirmation of the advising bank.
4.How the credit is to be
available, e.g. by
payment,
deferred
payment,
acceptance
or
negotiation. In most cases it will be the issuing
bank which will determine the bank authorized to
pay, or to accept drafts, or to negotiate, i.e.
the nominated bank Article 11(b), UCP).
4. The party on whom drafts, if any, are to be
drawn and the tenor of such drafts.
5. A brief description of the goods, including
details of quantity and unit price, if any.
6. Whether freight is to be prepaid or not.
7. Details of the documents required. The place of
dispatch or taking in charge of the goods,
or loading on board, as the case may be, and
the place of final destination.
8. Whether transshipment is prohibited.
9. Whether partial shipments are prohibited.

10.

The
latest
date
for
shipment
(if
applicable). The period of time after the
date
of
issuance
of
the
transport
documents(s) within which the documents must
be presented for payment, acceptance or
negotiation.
11. The date and place of expiry of the credit.
12. Whether the c
redit is to be a transferable one. (This would
have to be stated specifically by the
applicant). The specimen application form is
for a non-transferable credit.
13. How the credit is to be advised, i.e., by
mail, or by teletransmission i.e. SWIFT

TYPES OF CREDIT
There are various types of documentary credits. A
revocable credit can be amended or cancelled at any
time without prior warning or notification to the
seller.
An irrevocable credit can be amended or cancelled
only with the agreement of the issuing bank, the
confirming bank (if the credit has been confirmed)
and the seller (as beneficiary). As there are often
two banks involved, the issuing bank and the
advising bank, the buyer can ask for an irrevocable
credit to be confirmed by the advising bank. If the
advising bank agrees, the irrevocable credit
becomes a confirmed irrevocable credit.
Revocable Credit
Involves risk, as the credit may be amended or
cancelled while the goods are in transit and before
the
documents
are
presented,
or,
although
presented, before payment has been made, or in the
case of deferred payment credit, before the
documents have been taken up. The seller would then
face the problem of obtaining payment directly from
the buyer.
Irrevocable Credit
Gives the seller greater assurance of payment: but
he remains dependent on an undertaking of a foreign
bank.
Confirmed irrevocable Credit
Gives the seller a double assurance of payment,
since a bank in the sellers country has added its
own undertaking to that of the issuing bank.

Revocable Credit:
Gives the buyer maximum flexibility, as it can be
amended or cancelled without prior notice to the
seller up to the moment of payment by the bank at
which the issuing bank has made the credit
available.
Irrevocable Credit
Gives less flexibility, as the credit can only be
amended or cancelled if all the parties named above
agree. (It must be noted, however, that the credit
is issued in this form because the commercial
parties have so agreed in the sales contract).
Confirmed irrevocable Credit
Represents an additional requirement and is more
costly.
PRESENTATION
1.As soon as the seller receives the credit and is
satisfied
that
he
can
meet
its
terms
and
conditions, he is in a position to load the goods
and dispatch them.
2.The seller then sends the documents evidencing
the shipment to the bank where the credit is
available (the nominated bank).
3.The bank checks the documents against the credit.
If the documents meet the requirements of the
credit, the bank will pay, accept, or negotiate,
according to the terms of the credit. In the case
of a credit available by negotiation, the issuing
bank or the confirming bank will negotiate without
recourse. Any other bank, including the advising

bank if it has not confirmed the credit,


negotiates, will do so with recourse.

which

4.The bank, if other than the issuing bank, sends


the documents to the issuing bank.
The issuing bank checks the documents and, if they
meet the credit requirements, either
a)

b)

effects payment in accordance with the


terms of the credit, either to the seller
if he has sent the documents directly to
the issuing bank, or to the bank that has
made
funds
available
to
him
in
anticipation, or
reimburses in the pre-agreed manner the
confirming bank or any bank that has paid,
accepted, or negotiated under the credit
(Article 21, UCP).

TRANSPORT DOCUMENTS
The most important thing is the relevant transport
document!
The revision of UCP aims at a less troubled future
by recognizing and legislating for
a)

the case where the credit stipulates


dispatch of goods by post, so that the
appropriate transport document is a post
receipt or certificate of posting.

b)

the
case
where
the
credit
envisages
carriage by sea, with the traditional
marine bill of lading stipulated as the
required transport document.
all other cases where the credit calls for a
transport documents, e.g. where the mode of
carriage may be a combination of more than
one mode (combined transport), or may be air,
road, rail or inland waterway, with the
appropriate transport document a combined
transport bill of lading, an air waybill, a
road or rail consignment note, an inland
waterway bill of lading, or even, if so
stipulated in the credit.

c)

BILL OF LADING
This is the type of transport document normally
applicable to a carriage of goods solely by sea. It
is the transport document which must be presented
if the credit stipulates a marine bill of lading.
Unless otherwise stipulated in the credit this
document MUST indicate that the goods have been
loaded on board or shipped on a named vessel.

If the credit prohibits transshipment this document


will be rejected if it specifically states that the
goods will be transshipment.
COMBINED TRANSPORT BILL OF LADING
This is the type of transport document normally
applicable to a carriage of goods by more than one
mode of transport.
Unless otherwise stipulated in the credit this
document MAY indicate either dispatch or taking in
charge of the goods, or loading on board, as the
case may be.
COMMERCIAL INVOICE
A commercial invoice is the accounting document by
which the seller charges the goods to the buyer.
A
commercial
invoice
following information:

normally

includes

the

date.
name and address of buyer and seller.
order or contract number, quantity and
description of the goods, unit price (and
details of any other agreed charges not
included in the unit price), and the total
price.
*
weight of the goods, number of packages,
and shipping marks and numbers.
*
terms of delivery and payment.
*
shipment details.
*
*
*

CERTIFICATE OF ORIGIN
A certificate of origin is a signed statement
providing evidence of the origin of the goods.
In many countries a certificate of origin,
although prepared by the exporter or his
agent, has to be issued in a mandatory form
and
manner,
with
certification
by
an
independent official organization, e.g., a
chamber of commerce.
*
Such a document contains details of the
shipment to which it relates, states the
origin of the goods, and bears the signature
and the seal or stamp of the certifying body.
*

INSURANCE CERTIFICATE
The insurance document must:
1. be for the purpose that specified in the
credit.
2. be consistent with the other documents in its
identification of the voyage and description of
the goods.
3. unless otherwise stipulated in the credit,
a. be a document issued and/ or signed by
insurance companies or underwriters, or
their agents.
b. be dated on or before the date of shipment
as evidenced by the transport documents,
or appear to show that cover is effective
at the latest from such date of shipment
be for an amount at least equal to the CIF
value of the goods plus 10% and in the
currency of the credit.

SETTLEMENT
The seller may sometimes present documents that do
not meet the credit requirements. In such a case,
the bank can only act in one of the following ways:
1. Return the documents to the beneficiary
(seller) to have them amended for resubmission
within the validity of the credit and within
the period of time after date of issuance
specified in the credit, or applicable under
(UCP).
2. Send the documents for collection.
3. Return the documents to the beneficiary for
sending through his own bankers.
4. If so authorized by the beneficiary, cable or
write to the issuing bank for authority to pay,
accept or negotiate.
5. Call for an indemnity from the beneficiary or
from a bank, as appropriate i.e., pay, accept
or negotiate on the understanding that any
payment made will be refunded by the party
giving the indemnity, together with interest
and all charges, if the issuing bank refuses to
provide reimbursement against documents, that
do not meet the credit requirements.
6. Based on practical experience, and with the
agreement of the beneficiary, pay, accept or
negotiate under reserve, i.e. retain the
right of recourse against the beneficiary if
the
issuing
bank
refuses
to
provide
reimbursement against documents that do not
meet the credit requirements. In view of a
court ruling it would be advisable to make sure
that the beneficiary fully understands this
position.

BY PAYMENT
1. The seller sends the documents evidencing the
shipment to the bank where the credit is
available (the paying bank).
2. After checking that the documents meet the
credit requirements, the bank makes payment.
3. This bank, if other than the issuing bank, then
sends the documents to the issuing bank.
Reimbursement is obtained in the pre-agreed
manner.
BY ACCEPTANCE
1. The seller sends the documents evidencing the
shipment to the bank where the credit is
available (the accepting bank), accompanied by
a draft drawn on the bank at the specified
tenor.
2. After checking that the documents meet the
credit requirements, the bank accepts the draft
and returns it to the seller.
3. This bank, if other than the issuing bank, then
sends the documents to the issuing bank,
stating that it has accepted the draft and that
at maturity reimbursement will be obtained in
the pre-agreed manner.
Advising / Confirming bank
By accepting the draft, the bank signifies its
commitment to pay the face value at maturity. The
seller can, therefore, usually convert the accepted
draft into cash by discounting it with his own
bank, or on the local money market.
Issuing Bank

All credits must nominate the bank (nominated bank)


which is authorized to accept drafts (accepting
bank).
BY NEGOTIATION
1. The seller sends the documents evidencing the
shipment to the bank where the credit is
available (the negotiating bank), accompanied
by a draft drawn on the buyer or on any other
drawee specified in the credit, at sight or at
a tenor, as specified in the credit.
2. After checking that the documents meet the
credit requirements, the bank may negotiate the
draft. Negotiation by the issuing bank or the
confirming bank will be without recourse to the
seller. Negotiation by any other bank will be
with recourse to the seller.
3. This bank, if other than the issuing bank, then
sends the documents and the draft to the
issuing bank. Reimbursement is obtained in the
pre-agreed manner.
CLASSIFICATION OF TYPES OF LC:
1. REVOLVING CREDIT
A revolving credit is one where, under the terms
and conditions thereof, the amount is renewed or
reinstated without specific amendment to the credit
being needed.
*
*

It can be revocable or irrevocable.


It can revolve in relation to time
value.

and

2. RED CLAUSE CREDIT


A red clause credit:
is
a
credit
with
a
special
clause
incorporated into it that authorizes the
advising or confirming bank to make advances
to the beneficiary before presentation of the
documents. The clause is incorporated at the
specific request of the applicant, and the
wording is dependent upon his requirements.
*
is so called because the clause was
originally written in red ink to draw
attention to the unique nature of this
credit.
*
specifies the amount of the advance that is
authorized: in some instances it may be for
the full amount of the credit.
*
is often used as a method of providing the
seller
with
funds
prior
to
shipment.
Therefore, it is of value to middlemen and
dealers in areas of commerce that require a
form of pre-financing and where a buyer would
be willing to make special concessions of
this nature.
*

3. TRANSFERABLE CREDIT
A
transferable
credit
is
one
that
can
be
transferred by the original (First) beneficiary to
one or more other parties (second beneficiaries).It
is normally used when the first beneficiary does
not supply the merchandise himself, but is a
middleman and thus wishes to transfer part, or all,
of his rights and obligations to the actual
supplier(s) as second beneficiary(ies).
This type of credit can only be transferred once,
i.e., the second beneficiary(ies) cannot transfer
to a third beneficiary, The transfer must be

effected in accordance with the terms of the


original
credit,
subject
to
the
following
exceptions:
the
name
and
address
of
the
first
beneficiary may be substituted for that of
the applicant for the credit.
*
the amount of the credit and any unit price
may be reduced: this would enable the first
beneficiary to allow for his profit.
*
the period of validity, the period of time
after date of issuance of the transport
document for presentation of documents, and
the period for shipment may be shortened.
*
the percentage for which insurance cover
must be effected may be increase in such a
way as to provide the amount of cover
stipulated in the original credit.
*

It should be noted that a credit would only be


issued as a transferable one on the specific
instructions of the applicant. This would mean that
both the credit application form and the credit
itself must clearly show that the credit is to be
transferable. (Only an irrevocable credit would be
issued in this form).
The transfer is affected at the request of the
first beneficiary, by the bank where the credit is
available (the bank).
BACK TO BACK CREDIT
It may happen that the credit in favour of the
seller
is
not
transferable,
or,
although
transferable, cannot meet commercial requirements
by transfer in accordance with conditions. The
seller himself, however, is unable to supply the
goods and needs to purchase them from, and make
payment to, another supplier. In this case, it may

sometimes be possible to use either a back-to-back


creditor Counter credit.
Under the back-to-back concept, the seller, as
beneficiary of the first credit, offers it as
security to the advising bank for the issuance of
the second credit. As applicant for this second
credit the seller is responsible for reimbursing
the bank for payments made under it, regardless of
whether or not he himself is paid under the first
credit. There is, however, no compulsion for the
bank to issue the second credit, and, in fact, many
banks will not do so.
In the case of a counter credit, the procedure is
the same except that the seller requests his own
bank to issue the second credit as a counter to the
first one. His own bank may agree to issue such a
credit if the transaction falls within the sellers
existing credit line or if a special facility is
granted for that purpose. The bank will, of course,
have rights against him in accordance with the
terms of the credit line or special facility.
With both the back-to-back credit and the counter
credit, the second credit must be worded so as to
produce the documents (apart from the commercial
invoice) required by the first credit-and to
produce them within the time limits set by the
first
credit-in
order
that
the
seller,
as
beneficiary under the first credit, may be entitled
to be paid within those limits.
Green Clause Credit:
This is an improvement over the red clause credit
and permits not only pre shipment but also provides
for storage of goods in the name of opening Bank.
Deferred payment credit:

The payment is made in installments for the


purchase of heavy machinery and other capital
goods.
The principal types will be:
a)SIGHT
b)DA
BANKING FACILITIES:
Against sight and DA(usance) LCs, the following
facilities can be made available to the customer:
i)
ii)
iii)
iv)
v)
vi)
vii)

Payment Against Documents


Finance against imported merchandize (FIM)
Finance against trust receipts (FTR)
Finance against foreign bills (FAFB)
Foreign bills purchased (FBP)
Finance against packing credit (FAPC)
FOREIGN BILLS PURCHASED (FBP):
a) Finances the exporters receivable period.
b) The facility is for sight bill purchased.
c) Exporters do not stand to benefit/lose from
exchange rate fluctuations between local
and foreign
currency in which bill is denominated.
FINANCE AGAINST FOREIGN BILLS (FAFB):
a) Finances the exporters receivable period.
b) Exporters do not sell bills to the Bank but
get
finance.
c) Exporters stand to benefit/lose from
exchange rate
fluctuations between local and foreign
currency in which bill is denominated.

FOREIGN BILLS DISCOUNTED (FBD):


Similar with FBP except the period, this is usance
in this case.
The pre-shipment facility is risky from Bankers
point of
View.
There are two types of documents:
FINANCIAL DOCUMENTS:
a) Cheque
b) Bill of exchange
c) Promissory note
COMMERCIAL DOCUMENTS:
a) Transport documents
b) Documents of title
EXPORT FINANCE:
It works under Export Credit Guarantee Scheme
through Pakistan Insurance Corporation. It covers
the following areas:
a)
b)

Pre-shipment
Post-shipment

This scheme has following salient features:


PART-I:
It is granted against cases to case basis against
confirmed L/C or firm export orders.

PART-II:
It takes place on the basis of their previous year
performance with the help of export realization.
Repayment should be made within 180 days of the
bank borrowing unless and otherwise extended by the
Bank.
Part-II is allowed at 6/12 of previous years
export performance from any Bank.SBP has allocated
Rs.10B for refinancing. The mark-up rate will be 8%
maximum & 5% will be of SBP.

PART-B: FOREIGN EXCHANGE


BALANCE OF PAYMENT:
It is a measurement of all transactions across the
borders over a specified time period.
FOREIGN EXCHANGE TRANSACTIONS
i)

Current Transactions:
a) Goods and services during one financial
year i.e. visible items & it is called
balance of trade also. It includes non
visible items like services also & factor
income i.e. dividend payment & interest
payments across the borders.
b) Receipt and payments which do not
create
new
capital
items
or
cancel
previous
such
items
(visible
or
invisible).

ii)

Capital Transactions:

a) Receipts

and payments of capital nature


which do not pertain to current year.
It includes DFI, portfolio investment &
other capital investments.

b) Long term capital claims.


iii)

Short term financial Transaction:


a) Citizen of a country can transfer their
foreign exchange recourses to another
country due to political or economic
reasons.

iv)

Working Balances: The commercial Banks


maintain foreign currency deposit with
Banks in some other countries to avoid
various disturbances.

FOREIGN CURRENCY ACCOUNTS:


Banks play a vital role in the international
trade settlement. This settlement is made with
the help of NOSTRO and VOSTRO
NOSTRO:Latin word means OUR:
a)
b)
c)

A bank can have relationship


with foreign correspondents.
In UK, can have sterling
nostro a/c and so on.
They are in current account
and do not earn interest.

VOSTRO: a) Latin word means YOUR.


b)
Convertible
Pak.RS. accounts
maintained by foreign Banks.
EXCHANGE CONTROL

OBJECTIVES OF EXCHANGE CONTROL


Exchange control is
resources in foreign
following points:
i)

management of available
currency. It refers to

OVERVALUATION: More than the value determined


by market forces.

ii) UNDER
VALUATION:
Less
than
determined by market forces.

the

value

iii)STABILITY OF EXCHANGE RATES: Conversion at


official rate of exchange to stabilize
value.
iv) PREVENTION OF CAPITAL FLIGHT: Gold and
foreign
currency
cannot
be
exported
without Permission.
v)

PROTECTION TO DOMESTIC INDUSTRY: To encourage


business
environment in the country.

vi)
vii)

CHECKING NONESSENTIAL IMPORTS:


import of luxury items.

To

control

HELP TO PLANNING PROCESS: How to spend


foreign currency on result oriented items.

viii) BALANCE OF PAYMENT PROBLEMS: With prudent


policies BOP problem can be controlled.
ix)

x)

EARNING REVENUE: Foreign exchange is sold


to Businessmen, traders etc. at a certain
rate.
REPAYING FOREIGN DEBT: By
conserving Foreign exchange.

earning

and

xi)

RETALIATION:
Monopoly
bargaining terms.

power

and

better

FORMS OF EXCHANGE CONTROL


a)EXCHANGE RATIONING:
i)

To face foreign exchange difficulties, the


citizens will be required to surrender foreign
exchange earnings to SBP fully.
ii) Partial rationing
iii) Different official
transactions

rate

for

different

b)BLOCKED ACCOUNTS:
It refers to the following:
i)
ii)

iii)
iv)
v)

Bank deposits and other assets held by


foreigners in controlling country.
The interest and dividend can be used for
reinvestment in the same country but will
not be allowed to transfer or convert
funds.
Allowed to be utilized within the country,
if essential.
For export purposes.
Sometimes for traveling purposes.

c)PAYMENT AGREEMENTS:
It refers to the following points:
i)
ii)

Can
be
made
through
agreement between two countries, which
want rationing.
Can be made through agreement
between debtor and creditor countries.

iii)

Sometimes forced to be
creditor
for
encouragement
exports.

formed by
of
their

CLEARING AGREEMENTS:
i)
ii)

Direct bilateral exchange of goods.


May be between individuals and firms located
in
different countries.
ii)
More comprehensive as designed to settle
debt in
shortest possible time.
iv) The transactions are settled at an official
rate of exchange.
v)
Quantity and specification of goods is also
pre-defined.
vi)
Results are always not fruitful.
Precisely can be done by Government intervention
i.e. purchasing of foreign currency by selling
local currency as being done in Pakistan.
PREREQUISITES OF EXCHANGE CONTROL:
i)
ii)
iii)

iv)

Full control of Government over import and


export of gold and bullion.
Buying and selling of Government securities
should be controlled so that foreign
transactions are restricted.
Stock market operations must be monitored
closely so that conversion of foreign
assets
into
interest
bearing
foreign
securities may be avoided.
An
effective
custom
agency
is

required to control import and


export.

v)

Trade
control
may
be
exercised
to
ensure
early
repatriation
of
export
proceeds while free imports
may
be
controlled
for
a
favourable BOP.

The above mentioned methods are


DIRECT METHODS in which we can call
the OVERVALUATION as PEGGING UP and
UNDERVALUATION as PEGGING DOWN.
Besides, following are other direct
methods:
a) EXCHANGE RESTRICTIONS:
As per rules of SBP, forex
is released and kept by the
Government.
b) ALLOCATION AS PER PRIORITY
c) MULTIPLE EXCHANGE RATE.

INDIRECT METHODS:
a)QUANTITATIVE RESTRICTIONS:
There is import embargoes, import
quota and other restrictions to
control disequilibrium in BOP.

b)EXPORT
BOUNTIES:
exports,
provided
available with SBP.

To
encourage
funds
are

c)RAISING INTEREST RATE: It will


attract the inflow of deposits in
foreign exchange.
THE FINANCIAL MARKETS:
It is a set of facilities that makes
it possible to exchange money for
goods or goods for money on regular
basis. Securities are the goods.
Major functions of financial
markets:
a)
Shifting of credit:
Mobilize the funds for users.
b)
Liquefying securities.
Customer should be confident
about sale/purchase.
c)

Pricing: Mark-up rates.

d)
Foreshadowing future:
Forecasting of future for
financial management.
e)
Allocating resources:
Considering growth, safety and
yield.
CLASSIFICATION OF FINANCIAL MARKET:
a)
b)
c)
d)

Primary market.
Secondary market
Money market
Capital market

FUNCTIONS OF FOREIGN EXCHANGE


MARKET
Currently
operating
in
London,
Paris, Brussels, Zurich, New York,
Hong
Kong
and
Tokyo.

MOTIVES FOR INVESTING


EXCHANGE MARKETS:
a)

b)

c)

IN

FOREIGN

Economic
Conditions:
The
investors can invest in a
currency
where
economy
is
stable
so
return
can
be
higher.
Exchange rate expectataions:
The securities in a currency
may
be
bought
where
appreciation is higher than
the domestic currency.
International Diversification:
Risk & fluctuations can be
managed by investing in other
currencies.

MOTIVES FOR PROVIDING CREDIT


FOREIGN EXCHANGE MARKETS:

IN

a) Higher interest rates: Due to


shortage of forex reserves the
country may offer better rates
on foreign currency deposits.
b) Exchange rate expectations: One
can
make
investment
in
a
country
currency
which
is

expected to appreciate against


domestic currency.
c) International Diversification:
The
chances
of
risk
&
fluctuations can be avoided.
The economic conditions of the
concerned
country
are
very
important.
MOTIVES FOR BORROWING
EXCHANGE MARKETS:

IN

FOREIGN

a) Low
interest
rates:
Many
countries have bulk supply of
foreign reserves so rate of
interest are relatively low.
b) Exchange rate expectations: The
risk & return can be managed.

FUNCTIONS:
i)

To transfer purchasing power


from one country to another.
ii)
It takes place by debiting
and crediting accounts of each
Bank.

iii)

No
physical
delivery
of
currency takes place usually.
iv)
It provides credit also to
the business community.
v)
HEDGING: Hedging means
avoidance of foreign exchange
risk
or
covering
of
an
position without buying or
tying up funds. This process
is carried out in forward
Market. This promotes foreign
trade.
vi)

SPECULATION:

a)It is opposite of hedging.


b)The
speculator
takes
the
risk
Of any transaction.
c)Speculation can take place in
forward or spot market.
d)If the speculator buys a
currency in expectation of
reselling it on profit it will
be called LONG POSITION it
will have STABILIZING EFFECT
otherwise it will be called
SHORT POSITION or

DESTABILIZING EFFECT.
VII)SWAP TRANSACTIONS:
It refers to following:
i)
Simultaneous
buying
and
selling of foreign currency
for different delivery dates
in opposite direction.
ii)
May
cover
spot
against
forward.
iii)
May
take
place
between
commercial parties or Bank
etc.
iv) May be for a limited period
of time.
v)
May be lesser risky.
vi)
Very
popular
with
speculators, as well.

FOREIGN
EXCHANGE
MANAGEMENT:

POSITION

OVER BOUGHT/SOLD AND SQUARE


POSITION:

i)

ii)
iii)

iv)
v)
vi)

In
order
to
facilitate
foreign exchange transaction
the Banks buy/sell currency in
spot or forward.
The difference between buy
and sell shows the commitment
position of the Bank.
If purchase side is more than
sale
side
it
is
called
overbought and the opposite
one is called oversold.
If both positions are equal
it is called SQUARE.
If both positions are nearly
equal, it is called near
square.
Sometimes
delay
in
transmitting
takes
place,
which may disturb position.

LEADS AND LAGS:


If a foreign currency weakens or
it is devalued, the importers
stand to gain on their spot
purchases from the Bank while the

exporter will lose. The importer


and exporter will move accordingly
and this pressure will weaken the
currency. If a currency is strong
and is expected to be revalued
exporter will delay shipment and
the
importer
will
expedite
payment.
This
will
make
the
currency actually strong.
THIS PHENOMENON OF DELAYING AND
EXPEDITING SETTLEMENT BY CUSTOMERS
IN
ANTICIPATION
OF
CURRENCYS
DEVALUATION AND REVALUATION IS
CALLED LEADS AND LAGS.

SYSTEM OF EXCHANGE RATE


TWO major systems:

FIXED

RATE:

Remains fixed in
terms of foreign unit of currency
with
the
home
currency.
This
system has a demerit that when
there is adverse BOP, substantial
foreign exchange reserves will be
needed to maintain the rate at
fixed level.

FLOATING(FREE)RATE:

It

moves

in a following direction:
i)
Demand and supply of the
currency.
ii)
Places a currency at the
mercy of worlds judgment.
iii) May give rise to speculation.

TYPES OF EXCHANGE RATE:


DIRECT QUOTATION:
Rate of exchange is expressed in
units of national currency in most
currencies:
Rs.60=US$1

INDIRECT QUOTATION:
It values the currencies in terms
of the other currencies than in
national currencies.
US$ 0.5=Rs.1

CROSS RATES:
i)

ii)

iii)
iv)

v)

vi)

The rate of exchange between


any two currencies is kept the
same
in
different
money
centers by ARBITRAGE.
Sale and purchase is made in
and from money centers where
the currency is available at
lower
or
higher
rates
respectively.
When two currencies and two
centers are involved it is
called TWO POINT ARBITRAGE.
When three currencies and
three centers are involved it
is
called
THREE
POINT
ARBITRAGE OR TRIANGULAR.
When national currency is not
used in the transaction and
exchange rate is calculated on
the basis of a third currency,
it is called CROSS RATE.
It is known as calculated
parity
between
two
money
centers through a third e.g.

The chain rule is followed.

We can buy EURO in London against


GBP then can use EURO to
buy $ in France then we can sell $
in UK.

SPOT RATE:
The spot rate of the currency is the
value
quoted
for
the
nearest
settlement date for the purchase and
sale of the currency against another
one. The transaction may be settled
in two to three working days.

FORWARD RATE:
It covers following concepts:
i)

Rate at which the currency


can be bought or sold for
the delivery on a future date.
ii) Agreement to buy or sell at a
specified future date at rate
agreed today.
iii) No payment will be made
except security deposit at the
time of signing of contract.

iv)

No consideration for spot


rate
at
the
time
of
settlement.
v)
May be for one to six months
or longer.
vi) Longer period contracts are
not
common
due
to
uncertainties involved.
vii) If forward rate is less than
spot, it is called FORWARD
DISCOUNT otherwise it will be
called FORWARD PREMIUM.
viii) With
its
the importer/exporter
avoid
fluctuations.
ix)
x)

help
can

The Bank can take help from


speculators.
There can be BULL or BEAR
run.

OTHER SYSTEM OF EXCHANGE RATE:


i) Dirty float:

a) To avoid sharp changes in


rates under any system.
b) It is a compromise between
fixed & floating rate system.
c) Can be done with interest rate
policy.
d) The objective is to stabilize
rate of exchange.
ii) Wider band:
a) The rate can be moved in 2.25%
range on either side of
official rate of exchange.
b) It was allowed by IMF in 1971 for
the first time.
c) Total variation comes to 4.5%.
d) It helps in avoiding currency
uncertainty.
iii) Crawling Peg:
a) The value of currency is revised
automatically.
b) There is a support point when it
reaches then the central
bank intervenes.

c) According to previous agreed


weeks or months the support
point is changed based on
currency average.
d) If new support point is near to
low point then it will be
set downward otherwise upward.
e) It gives certainty to rate of
exchange.
CURRENCY DERIVATIVES
A forward contract is an agreement
between a company & a commercial
bank to exchange a specified amount
of currency at specified exchange
rate (forward rate) on a specified
date in the future. The normal
period is 30, 60 & multiple. Initial
deposit may be needed.
BID/ASK RATE:
The ask rate is the selling rate
whereas bid rate is the purchase
rate. The spread between bid & ask
rate is wider in forward contracts.

How to calculate BID & ASK rate in


%:
Ask rate-Bid rate/Ask rate
A future contract refers to a
specific settlement date for a
particular currencys volume. It is
popular with speculators.
DIFFERENCE BETWEEN FORWARD & FUTURE
CONTRACTS:

FORWARD
Size
of Tailored
contract
to
individual
needs
Delivery
Tailored
date
to
individual
needs
Participant Bankers,
s
brokers,
MNC,
speculator

FUTURE
Standardize
d
Standardize
d
Bankers,
brokers,
MNC,
qualified

s
not speculators
encouraged
Security
Not
Needed
deposit
essential
Transaction Set
by Negotiable
cost
spread
CURRENCY CALL OPTIONS:
It grants right to buy specific
currency at a designated price
within a specific period of time.
The currency options are desirable
when one wishes to lock in a maximum
price to be paid for the currency in
the future. The price at which the
person is allowed to buy that
currency is known as exercise/strike
price.
Call options are desirable when.
a) One wishes to lock maximum
price to be paid for a currency
in the future.
b) If the spot rate of currency
rises above strike price owners
of call options can exercise

option by purchasing it at
strike price.
c) Future contract is obligatory
but currency option is not.
d) Owners of call option loses
premium paid by them initially
but that is maximum.
A currency call option is said to be
in the money when present exchange
rate exceeds strike price, at the
money when both are equal & out of
money present exchange rate is less
that strike price. Higher premium is
there in the money option.
FACTORS
AFFECTING
OPTION PREMIUM:

CURRENCY

CALL

a) Higher the spot rate relative


to strike price, higher the
option price will be. This will
be due to higher probability of
buying currency at lower rate
than what you could sell it
for.
b) The relationship of expiration
date & premium is there.

c) If time is long then chances of


raising the spot rate will be
higher as compared with strike
price.
d) The volatility of currency can
increase
spot
price
more
rapidly.
CURRENCY PUT OPTIONS:
It grants right to sell specific
currency at a designated price
(strike price) within a specific
period of time. It is also not
obligatory like call option.
The owners of put option loses
premium paid by them initially but
that is maximum.
A currency put option is said to be
in the money when present exchange
rate is less than strike price, at
the money when both are equal & out
of money when present exchange rate
exceeds the strike price. For a
given currency & expiration date, an
in the money put option will require
a higher premium than options that

are there in at the money or out of


money.
EXAMPLE FOR CALL OPTION:
Call option premium on C$=$.01/unit
Strike price=$0.70
One option contract represents C$
50,000
Amount in C$
Narration
Per
unit Per
price
contract
Selling
0.74
37,000
price of C$
Purchase
-0.70
-35,000
price of C$
Premium
-.01
-500
paid
for
option
Net Profit 0.03
1,500
If the seller does not purchase
the C$ till option was about to be
exercised the net profit of seller
will be as follows:
Amount in C$
Narration
Per
unit Per

price
0.70

Selling
price of C$
Purchase
-0.74
price of C$
Premium
.01
received
for option
Net Profit -0.03

contract
35,000
-37,000
+500
-1,500

EXAMPLE FOR PUT OPTION:


Put option premium on GBP=0.04/unit
Strike price=GBP1.40
One option contract represents GBP
31,250
Amount in GBP
Narration
Per
unit Per
price
contract
Selling
1.40
43,750
price
of
GBP
Purchase
1.30
40,625
price of C$
Premium
-.04
-1,250
paid
for
option
Net Profit 0.06
1,875

If the seller does not purchase


the GBP till option was about to
be exercised the net profit of
seller will be as follows:
Amount in GBP
Narration
Per
unit Per
price
contract
Selling
1.30
40,625
price of C$
Purchase
-1.40
-43,750
price of C$
Premium
.04
+1,250
received
for option
Net Profit -0.06
-1,875
EURO CURRENCY MARKETS: They exist
in
all
countries
to
transfer
surplus units (savers) to deficit
units (borrowers).So out side USA
demand of $ will be called EURO
DOLLARS & so on for long term it
will be EURO BONDS.
DIRECT FOREIGN INVESTMENT:

Investment in real assets like


land, buildings etc in the foreign
countries are called DFI.
MOTIVES:
Normally the objectives are to
maximize share holders wealth &
to improve profitability but they
can be interested in boosting
revenue, reducing costs or both.
REVENUE RELATED MOTIVES:
a) Attract new source of demand:
This can be done to avoid
domestic
competition
&
to
increase growth.
b) Enter profitable markets: When
the other market is profitable
MNC can take its benefit.
c) Exploit
monopolistic
advantages: More chances for
technically advanced MNCs &
products in other markets.
d) React to trade restrictions:
May enter in other markets

where trade restrictions are no


there.
COST REALTED BENEFITS:
a) Fully benefit from economies
of scale: Lower average cost
with more production.
b) Use
foreign
factors
of
production:
Set
up
where
factors are available at cheap
rates.
c) Use foreign raw material: Let
us set up factory where raw
material is available. This is
to avoid many hindrances.
d) Use
foreign
technology:
Advanced
technology
can
be
used & can be imported to home
country of MNC.
e) React to exchange movements:
When
the
currency
is
undervalued then MNC can go
for FDI to take benefit of
initial low outlay.

OFFSHORE BANKING:
i)

Bank decides to deal


foreign nationals.
ii) In the non-tariff area.
iii)
May
be
free
legislations.

with
from