UNIT-1INTERNATIONAL FINANCIAL

MANAGEMENT

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CONTENTS09/04/2023

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Introduction to financial management

An overview of international economy in India

International financial environment

Multinational Corporations

Theories of International business,

International Business Methods,

International Monitory system

International risk exposure

FINANCIAL MANAGEMENT

Financial Management represents the bridge between the firms

real assets and financial assets

(Capital budgeting)

Real assets

Financial Management

(Financing)

LoansEquityshares

Objectives of F M

Primary - Profit maximization

- Maximize the wealth of the owners (share holders)

Others - Ensure financial stability

Functions of F M

Planning - Ascertain and determine the source of financing the needs

Organization - Procurement and allocation of funds.

Control - Monitoring of funds through financial discipline.

PRIMARY ROLE OF F M

Mobilization

of funds

From where ?

At what cost ?

In what time ?

Deployment

of funds

Fixed assets

Current assets

Investments

Repayment of

debts

Control end

Use of funds

Ascertaining facts

& figures through

Reports

Cash flow

Risk-return

Trade-off

Investment

(Risk-return)

Financing

(debt-equity)

OTHER ROLES-

Treasury operations

Short term funds Management

Speculative gains by anticipating interestrate movements

Foreign

exchange

Currency fluctuation

Hedging

Forward Contract .

Maintaining

share price

Dividend policy

Bonus policy

Healthy level of

share price.

Financial

structuring

Debt- equity

Arbitrage

Pricing of new issue

FINANCIAL FUNCTIONSFINANCIAL FUNCTIONS

AnticipationOf funds needed

Acquire the funds needed

MaximizeFirms value

Proper planning

Effective monitoring

UtilizationOf the funds

Increaseprofitability

Reducing the costs

Efficient allocation

Most profitable manner.

Long term

Short Term

Domestic

International

At least cost

For financing the assets / projects

OVERVIEW TO I F M

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I F M has assumed significance after liberalization

More & more FDI’s, FII’s & F F I’s are in Indian market

F F I’s hold over 20% of market capitalization

Many Indian corporates are listed in foreign stock exchanges.

Indian exports are growing at a rate of 12%/ annum with 50% of manufacturing items being exported.

India is not a land of billion problems , but a land of billion opportunities

Mukesh Ambani

OVERVIEW TO I F M

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Total forex trade has crossed 450 billion US $ & forex assets are over

US $ 300 billions

India is a creditor country among IMF members. Many Indian companies have acquired big ones abroad (Indian MNC)

FDI & NRI continue to grow even in the recession years though there may be a negative situation at times.

Many international companies look to India for their market.

The GDP continue to grow over 7 %

OVERVIEW TO I F M

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With such a scenario and the future though tense is bright too , it is essential for the Finance managers to have fairly good knowledge on international financial management.

The company’s operations today are global & the finance man has to be well aware of the various intricacies on export/ import/ forex front.

The mutual interactions between foreign sector of various countries lead us to International financial system .

The institutions operating in the international financial system are closely connected with the foreign sectors of various economies.

INTERDEPENDENCE INTERDEPENDENCE

EquityParticipation

In Indian companies

InvestmentIn bonds

& debentures

TechnicalConsultancy Transfer of Technology

GrantingLoans/ credits

on Govn,tto Govn,t basis,

Party to Party basis

J V in third countries

In view of global importance to the operations in international trade & funds flow, the importance of international financial management has

assumed vital role.,

IFM TO TODAY MANAGERS09/04/2023

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Managers should have a good knowledge of both domestic & international markets in globalized world.

Operations of domestic & international markets are different & hence the factors influencing them should be studied separately.

Survival of the fittest is the watch word. A right exposure in international & domestic finance for managers are preferred.

The activities of MNC with international forces today needs managers with good command over international operations.

No manager can be blind on the international economic & financial operations today.

INTERNATIONAL ENVIRONMENT09/04/2023

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International environment

Economic &

Financialfactors

Social&

Culturalfactors

Technological& other factors

Demographic factors

Naturalenvironment

Political&

Governmentpolicies

RecessionDepressionBoomInflationGDPExchange rateCurrency fluctuationCommodity price

StabilityLegal systemEfficiency executive/ Legislative/judiciaryCorruptionFiscal policyOther policiesstandards

Public interestTasteConsumptionBeliefs

Size, age, gender of the PopulationLanguage, casteReligion

Climatic conditionTransportPowerStandards of living

QualityStandardsEfficiencySkills

M N C’S

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MNC trade & production has been increasing over the last decades

They control 1/3 rd of world production is controlled by MNC’s.

The total sales of MNC will be 25% of world sales

Bulk pvt investments are from MNC’s

Induction of latest technology & exploitation of natural resources are by MNC’s. Globalization led to the growth of MNC”s

A MNC is an enterprise which has its managerial H Q located in one country & operations in number of countries.

They expand either by setting up branches abroad , JV, subsidiaries etc.

Expansion takes place through vertical / horizontal / conglomerate route.

M N C- OBJECTIVES

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Economies of scale, expansion of operations globally

Diversification of product range to reduce risk

Cost minimization & profit maximization

International collaboration

Secure inputs & intermediaries from different countries at low cost , assemble them in their own country & sell them back globally

M N C- FEATURES

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Seeking capital at low cost markets on international basis

Investment proposals are decided on global basis.

Integrate their world wide operations

Flexible in planning , adaptability to the environment, quickness in decisions , innovative , vision, selecting best talent , profitable , efficient MIS, well developed R & D etc

They have different state of mind. They think global, plan global, act global.

The plant size, operations, activities, place are global.

The MNC’s F M differs from D FM in many ways.

M N C’S - DC’S

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Larger investments in R & D

Control on cheaper capital

Rating is higher

Capital intensive

International diversification

Ambitious & expansionist

Sound F M

Less investments in R & D

Not much excess reserves

Struggle to get good rating

Not Capital intensive

Domestic diversification

Less ambitious

Not efficient F M

INTERNATIONAL TRADE THEORIES

Classical theory

Barter V/s money trade

Absolute advantage theory

Comparative advantage theory

Reciprocal demand theory

Modern theory(General Equilibrium theory )

Heckscher Ohlin theorem

Some recent theories

Karvis theory

Technology & trade theory

CLASSICAL THEORIES

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Barter trade V/S Money tradeTrade between commodities without any exchange of money.. This was prevalent between any two countries. After advent of IMF , multilateral trade is encouraged . Still some countries practice barter trade on a limited basis

Classical trade theory- Absolute Advantage ( A A)Value of product in a country is determined by its labour contents. As labour cannot move internationally , this was used as absolute advantage by some countries as per Adam Smith.

Production of one man in one week

product In USA In India

wheat 8 kgs (A A) 2 kgs

Cloth 2 yards 6 yards ( A A)

Exchange rate between wheat & cloth in India is 1;3 whereas it is 4;1 in USAIf wheat of USA is exchanged for cloth of India, the ratio will be between 1: 3 & 4:1

CLASSICAL THEORIES

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Comparative advantage theory

Developed by David Ricardo

The country would export that commodity in which it had a greater Comparative advantage & import a commodity in which it had a greaterComparative disadvantage.

Example- If no trade takes place , India will have only 2 kgs of wheat & 6 yds of cloth. With trade taking place, it can produce 12 yds of cloth, export 6 yds & retain balance for its use. It can also get 3 kgs of wheat even at domestic exchange ratio in US.

(Assumption- Only labour is taken into consideration, no trade & tariffs, unrestricted flow of trade, cost of transport & insurance ignored )

CLASSICAL THEORIES

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Reciprocal Demand theory

Propounded by J S Mill

Law of comparative costs determines the supply of goods in foreign trade as per David Recardo.

Law of reciprocal demand sets the price at which the trade will take place. i.e , it is the law of supply & demand that will determine the price. ( It is the US demand for Indian cloth & Indian demand for US wheat)

The offer & bids in the international trades are represented by offer curves. These curves can be regarded as demand curves representing various amounts of cloth which USA would demand in exchange for a unit of wheat & units of wheat which India would demand for exchange of one unit of cloth.

Modern theory of international trade

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Classical theory explains trade based on the cost difference which in turn Is dependent on the labour or other factor efficiencies.

The modern theory also called general equilibrium theory is based on demand & supply principles.

It shows that there is hardly any difference between internal & international theories.

Modern theory of international trade

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Modern economists were of the view that there is no need for a separate theory in view of the following 1. Factor mobility among countries is restricted as in case of regions within a

country .

2. Difference in currencies among nations do not stand in any way of trade as there is arrangement for exchange of currencies in forex market.

3. Transport cost is there both for international & domestic trade.

4. Comparative cost difference is there both for domestic & international trade.

5. The other differences such as habits, customs, trade restrictions are not insurmountable.

INTERNATIONAL BUSINESS THEORIES

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Heckscher- Ohlin theorem

According to this theory , a country with capital abundance will export capital goods & those countries with labour abundance will export labour intensive goods.

Ex- USA can export capital intensive goods in exchange for labour intensive goods by India.

(PK/ PL) A < ( PK/ PL)

P= price factor , K= capital, L = labour, A & B are two countries.

For trade to take place between two countries , there should be difference in factor efficiencies and for each commodity .

What is said for factor of production can also be true for goods as they are the inputs in productive activities

RECENT THEORIES

Karvis theory

Also called availability theory

Those countries which have exportable surplus will export to other countries.

Consumers preference for the goods of a

particular country also holds good.

Technology & Trade theory

Technology difference may lead to

trade advantages.

Introduction of new technology may

lead to trade in that goods & from that

country.

The country which introduces new

technology first will increase its exports

Emerging models of international theories as per economists areRicaro goods, Herkscher – Ohlin goods & Technology goods

INTERNATIONAL BUSINESS METHODS

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Globalization

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Globalization / deregulation / liberalization has made business more competitive & challenging.

Indian companies have become MNC’s & foreign MNC’s have entered India .

Business methods adopted by various companies have also undergone changes.

Globalization had brought remarkable effect on following areas.

1. corporate strategy & corporate Governance.

2. Corporate goals & objectives

3. Corporate financial strengths & weakness

4. Input market, output market both in direction & content.

International Business environment.

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Financial markets opened up & are dynamic & volatile in globalized set up

IT & telecommunication media has made world a global village.

Competition is severe & those who are weak/ late will not survive.

Natural forces will act, interest rates moves freely & exchange rates are dynamic.

Those who are agile & alert can survive.

Those management who have skilled power/ financial strong / optimize share holders value by adopting to changes can be global MNC’s.

Corporate management have to adapt to new situation .

They have to change strategies & undergo a deep transformation to meet the challenges

Global factors

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Capital flow will be from less efficient / less profitable ventures / markets to more efficient & profitable markets.

Capital can now be sourced from cheaper markets internationally.

Human skills & technology will also see mobility.

Free exports & imports can reduce the costs due to comparative advantages

Both short term & long term finances can be available both from Domestic & international markets.

Availability of capital when required can reduces locking of funds at high cost borrowings.

JV, M & A, Disinvestments , putting weight in profitable directions will be the order of the day.

Global factors- (Contd)

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Multicurrency loans, flexi rate loans, ECB,s , guarantees , bridge loans will be available in global markets.

Changes in legal frame work has brought in International court of justice.

Borrower & Lender have to abide by a legal system which is acceptable to both.

International chamber of commerce & International court of justice are the agencies on legal issues.

The documents & agreements between parties may specify the law of their choice which should govern their contract.

Government will take up with international court of justice

Individuals & corporate bodies can approach the International chamber of Commerce for adjudication.

Production sharing will be the most important form of economic integration Peter Drucker

Global sourcing

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One of the main characteristics of MNC is global sourcing for inputs & financial resources.

Japan/ USA increasingly depend on outside source depending on lowest global cost alternatives.

Toyota of Japan outsource 60 to 70% of their requirements & General Motors of US to the extent of 30-40% .

Reasons for global sourcing are

1. Price/ cost/ quality2. Advanced technology3. Prompt , co-operative delivery & consistent attitude. 4. Agreement with subsidiaries/ counter trade requirement.5. Reduction of use of capital/ labour. The issues in global sourcing are

6. Reduction in flexibility of own planning7. There might be some hidden cost8. Possibilities of changes in currency exchange rate.

GLOBAL ORGANIZATIONAL STRUCTURE

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organization under globalization is a dynamic phenomenon.

It involves integration of organization theory, organization functions, organization design, organization performance etc.

Organization, components, activities are influenced by environment which is influenced through human behaviour.

This involves human adaptation & behavioral adaptation of the organization.

Each organization has evolved on the basis of culture, tradition & precedents.

Organization design for globalization involves various factors

ORGANIZATIONAL – DESIGN FOR GLOBALIZATION

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Steps for globalization

1. Size & type of business

2. Structure , strategies & systems

3. Human behaviour & culture

4. Human Resources Development

Training Adaptation Professionalism Mind set

Foreigntechnology

GovernmentPolicies & proceduresof host/ home countries

Global BusinessPractices of Foreign Banks& markets

LawForeignfinance

Attitude

INTERNATIONAL MONITORY SYSTEMIMF

WORLD BANK

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International Monitory –Pre war period

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Gold standard was followed by various countries prior to first world war -1914.

The exchange rate between two countries was determined on the basis of the rates at which two countries could convert their currencies for one ounce of gold.

Ex- If one ounce of gold was $ 400 in Us & sterling Pounds 200 in G B, then the $ - pound convertible rate was $ 2 / pound.

Countries continued on Gold standards due to its inherent advantages. ( Price stability of gold)

This was abandoned with the advent of W W 1 and modified version of Gold standard Called gold exchange standards came into force.

In this system, some countries committed converting their currencies into the currenciesof other countries on gold standards rather than gold.

II W W effectively stopped all international economic activities.

International Monitory system- Bretton Woods system

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Second world war has led to international monitory disorder , Exchange restrictions,undesirable trade practices.

Need for international monitory co-operation & understanding was greatly felt after the war.

Britton Woods conference resulted in establishment of IMF & ( IBRD ) world bank.

44 member countries met at Britton woods , New Hampshire , USA & signed an agreement for establishing a new monetary system .

Later more countries joined & almost all countries (184) are now members .

Objectives of International Monitory Fund ( IMF)

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1. To promote international co-operation through consultation & mutual collaboration

2. To promote exchange stability & maintain orderly exchange arrangements.

3. Avoid competitive exchange depreciation

4 To help members of temporary balance of payment difficulties & to tide over them without resort to exchange restrictions.

5. To promote growth of multilateralism in trade payments & expand world trade

6. To help achieve balance of payments equilibrium , shorten the duration of disequilibrium & promote orderly international relations.

Importance of IMF

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In all matter of exchange rate changes, , imposition of restrictions on currentaccount , use of discriminatory practices, members are obliged to consult IMF

If the members fail to consult IMF, they would be ineligible to have recourse to financial resources.

The consultations include the following

1. Supply of economic & financial data to the fund by the member countries

2. The staff of the fund can call various types of data from a member country on ad hoc basis.

3. The staff team visits member countries once an year for a first hand study on economic & financial conditions in the member country.

4. Formal & informal consultations are held with member countries when they approach for standby arrangement or credit withdrawal.

Sources of funds for IMF- The Quotas

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Every member country in the IMF has been allotted a quota ,

The formula was worked out based on the following

1. 2 % of the national income

2. 5 % of the gold & $ balances

3. 10% of the average annual exports

4. 10% of the maximum variation of annual exports

5. The sum of the above , increased by the % ratios of average annual exports to national income of the member.

Each member’s quota was fixed as their initial contribution to the fund.

The total quotas as on 1944 of 44 countries was $ 8800 million & by 1994 the number of countries were 178 & quota was SDR- 144,620 million

Special drawing rights ( S D R )

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Historically Gold was taken by the US $ & U K sterling pound in inter war & post war period.

This was replaced by Special drawing rights ( S D R ) after seventies.

SDR is now the standard unit account whose value will be fixed in terms of basket of currencies.

SDR is a source of augmenting international liquidity.

This is an asset specially intended to replace Gold and is called paper gold.

The value of SDR is fixed on daily basis as weighted average of a basket of 16 currencies of countries with more than 1 % of world trade .

Since 1981, the value of SDR is based on the weighted average of 5 major currencies namely US $, DM, UK pound sterling, French Frank & Yen,

Since 2005 , it is UK pound sterling, US $, Euro & Japanese Yen.

Other sources of fund for IMF

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IMF holds substantial quantum of gold reserves which was received as Quota from its members . Only 25% of the gold was converted into SDR’s.

In 1975 , IMF sold 1/6 th of gold reserves in auction which realised US $ 5.7 billions

Under general agreement to borrow, IMF could borrow from its participating members ( G-10 countries), which will be repaid with interest in 5 years period.

IMF can also acquire any currency in exchange for its gold reserves.

The repayment made by member countries is also a source for further lending.

I M F- BOARD

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There are 22 directors on Board.

6 of them are appointed by those governments who hold largest quotas.

The rest are appointed by other countries

The M D / Chairman is appointed for 5 years period.

The board meets once an year to take major policy decisions.

Its members are mostly finance ministers / central bank governors of member countries

All member countries are represented on this board.

I M F- LENDING OPERATIONS

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Provides temporary assistance for balance of payment purposes.

A member can draw up to 25% of its quota (Gold tranche) in gold automatically.

Further 100% of its quota can be borrowed in 4 stages with strict restrictions.

If that country has 10% credit position as its quota as borrowings by other countries ( super gold tranche) , it can draw up to 35 % of its quota.

IMF lends under various schemes

I M F- SCHEMES09/04/2023

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Standby Arrangement1952

Compensating Finance Facility1963

Buffer stockFinancing Facility 1969

ExtendedFacility 1974

country can Borrow at first Indication Without getting the Loan approvalto save time

Financial assistanceTo countries facingTemporary shortfall

Financial assistanceFor purchase of Approved primaryProducts to avoid Price shocks

Borrow on mediumTerm basis to OvercomeBalance of paymentProblem due to Structural imbalance

POST BRITTON WOODS SYSTEM (CURRENT SYSTEM)

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Britton woods system was abandoned & most of the countries shifted to floating exchange system from 1976.

Under this system, countries were given flexibility to choose the exchange system they wanted to follow in managing their exchange rates.

The countries can float / peg their currencies with basket of currencies / SDR. Pegging with gold was abandoned.

Members no longer required to deposit their quota in gold.

IMF reduced the role of gold and SDR became reserve asset.

IMF became more powerful & was given the responsibility of supervising the monitory system.

POST BRITTON WOODS SYSTEM (CURRENT SYSTEM)

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As of 1995, of 155 members in the fund, the following were the exchange rate mechanism followed by various countries

Currencies pegged to No of countries

U S $ 27

French frank 14

SDR 6

Currency basket 34

Independent float 27

Joint Float 5

Other currencies 42

POST BRITTON WOODS SYSTEM (CONT’D)PRINCIPLES OF EXCHANGE RATE MANAGEMENT

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A member country neither should manipulate the exchange rates in such a way to prevent a correction in BOP position.

Countries should use the exchange rate to gain competitive advantage in international market.

Member country shall intervene in the exchange market If necessary

to counter disorderly conditions

While intervening in exchange markets, , a member country should keep the interest of other countries in mind.

Members are free to choose their exchange rate arrangements except to maintain value in terms of SDR

They should co-operate with fund in orderly exchange arrangements.

IMPORTANCE OF RESERVES

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Just as one needs domestic cash requirements for transactions, countries need reserves to meet payments in international transactions.

The adequacy of reserves is also important ( reserves to imports, rate of growth of world trade to rate of growth of reserves & magnitude of balance of payments deficit)

Under floating rate system, a larger need for reserves is a must to meet the BoP.

Increasing BOP by non oil producing countries require more reserves

to meet the deficit.

Many poor countries have their exchange rates pegged to a currency or basket of currency for which central bank intervention is needed in the market

INDIA'S - RESERVES09/04/2023

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Indians currency exchange rate is linked to basket of currencies.

India’s reserves position is comfortable and is now almost equal to one year’s imports .

The reserve’s position comprises of Gold, Foreign exchange assets, & SDR’s. The reserve levels over the last 50 years (Rs in crs) are as follows.

March 71

March 81

Jan 94 Dec 99 June 02 June09

Gold 182 226 12,665 12,790 16,272 46,914

Forex assets

438 4,822 61,440 1,39,134 2,67,333 12,16,345

SDR 112 497 233 18 47 2

Total 732 5,545 74,338 1,51,942 2,83,652 12,63,261

UNIT-1CONCLUDED

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