Inroduction to IFM

8/13/2019 Inroduction to IFM

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INTERNATIONAL

FINANCIAL MANAGEMENT


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1.1 Why Study International

Finance In today's world finance cannot be

anything but international

Enormous growth in the volume of

international trade

Cross border capital flows and, inparticular, direct investment have also

grown enormously


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Finance (contd.)

Veritable revolution has been taking place

in the money and capital markets around the

world

Liberalization, integration and innovation

have created a giant international financialmarket which is extremely dynamic and

complex


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Multilateral negotiations regarding phased

removal of trade barriers have made

considerable progress and WTO had emerged as

a meaningful platform

Post war, World trade has grown faster than

World GDP

Almost all countries getting integrated with

the global economy


Finance (contd.)


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1.1 Why Study InternationalFinance (contd.)

Indian economy needs substantial amountsof foreign capital to augment domesticsavings

Technology up-gradation in India willrequire continuing import of foreigntechnology, hardware and software

Indias increasing recourse to commercialborrowings and direct and portfolioinvestments by nonresidents


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Finance (contd.)

The efforts of Indian companies to diversifyinto exports of engineering equipment andturnkey projects will have to be supported

by the ability to offer long term financing tobuyers

A number of companies particularly in theIndian IT sector have begun venturingabroad for strategic reasons either aspartners in joint ventures or by establishingforeign subsidiaries


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India's growing dependence on international

financial markets

Debt Equity

FII investment

Indian companies have also been venturingabroad for setting up joint ventures and

wholly owned subsidiaries


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For those who are willing to master its

complexities the global financial market

provides endless opportunities for creativefinancial management; for the unwary, it is

a minefield

Finance managers must come to grips withthe conceptual foundations and practical

issues of instruments and markets


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INTRODUCTION

CASE STUDY Jim Logan completed UG degree in finance.

Dream of owning sports business.

Worked in a sporting goods shop whilestudying and observed that customers wantto buy low priced foot ball.

But the shop sold only top line foot balls. Hence decided to penetrate the US market

with low priced foot ball.


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Also knew how to produce foot ball.

Goal was to make low priced foot balls and

sell them on a whole sale basis. But many sporting goods stores started

selling low-priced footballs just before Jimwas about to start.

Jim did not believe that he would competewith these in the US market and henceplanned to go global.


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He enquired with his foreign friends aboutthe possibility of getting customers in the

foreign markets. But explored the possibility of getting good

demand from the foreign market.

Jim decided to start a business of producinglow priced foot balls and exporting them tosporting goods distributors in foreigncountries.


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Jim planned to expand his product line overtime once he identified other sports

products. He decided to call his business Sports

Exports Company to avoid any rent andlabor expenses.

Jim planned to produce the foot balls in hisgarage and to perform the work himself.


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Thus his main expenses were the cost ofthe material used to produce and expenses

associated with finding distributors inforeign countries.

Q:1 Is Sports Exports Company amultinational corporation?

2.Why are the agency costs lower forsports Exports Company than for mostMNCs?


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3.Does Sports Exports Company have anycomparative advantage over potential

competitors' in foreign countries that couldproduce and sell footballs there?

4. How would Jim Logan decide whichforeign markets he would attempt to enter?

Should he initially focus on one or manyforeign markets?


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5. The Sports Exports Company has noimmediate plans to conduct direct foreign

investment. it might consider other lesscostly methods of establishing its businessin foreign markets. What methods mightthe sports Exports Company use to increase

its presence in foreign markets by workingwith one or more foreign companies?


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solution

1.Definition of MNC:

The firms which are engaged in some

form of international business is known asmultinational corporation.

2. Agency cost definition:

Conflict between managements goal andobjective of the firm leads to agency cost.


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3. Theories of International Business:

Theory of comparative advantage

specialization in one product may result inno production of other products so thattrade between countries is essential.

Theory of Imperfect Market:

Factors of production are immobile.Restriction on free transfer of funds andother resources.


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Product Life Cycle Theory:

Stage1 : Firms create products to

accommodate local demand.Stage 2. Firms exports product to

accommodate foreign demand.

Stage 3. Firm establishes foreign subsidiary toestablish presence in foreign country andpossibly to reduce costs.


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Stage 4 a.- Firm differentiates productfrom competitors and / or expands

product line in foreign country. 4b.Firms foreign business declines

as its competitive advantages are

eliminated.


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Q5

Methods of International Business:

International Trade.

Licensing Franchising

Joint ventures

Acquisitions of existing operations Establishing a new foreign subsidiaries.


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The process of Expansion

LICENSING

EXPORTINGSALES SUBSERVICE

FACILTIYDISTRIBUTION SYSTEM-

PRODUCITON OVERSEAS.


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The Finance Function

The finance function in a firm can be

conveniently divided into two sub-

functions viz. accounting and control

and treasury management

Decisions taken by the treasurer have

implications for the controller and vice

versa


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The Finance Function (contd.)

Treasury Function: Acquisition andallocation of financial resources so as tominimize the cost and maximize thereturn, consistent with the level offinancial risk acceptable to the firm isthe core of treasury management

Accounting and Control: Internal andExternal Reporting, MIS, Control, etc.


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The Emerging Challenges

Five key categories of emerging challengescan be identified

To keep up-to-date with significantenvironmental changes and analyze theirimplications for the firm

To understand and analyze the complexinterrelationships between relevant

environmental variables and corporateresponses - own and competitive - to thechanges in them


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The Emerging Challenges(contd.)

To be able to adapt the finance function to

significant changes in the firm's own

strategic posture To take in stride past failures and mistakes

to minimize their adverse impact

To design and implement effectivesolutions to take advantage of the

opportunities offered by the markets and

advances in financial theory


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Recent Changes in GlobalFinancial Markets

The outstanding feature of the changesduring the eighties was integration

Both the potential borrower and the

potential investor have a wide range ofchoice of markets

there has been a strong trend towards

functional unification across the varioustypes of financial institutions withinindividual markets


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Recent Changes in GlobalFinancial Markets (contd.)

The driving forces behind this spatial

and functional integration were first,

liberalization of cross border financial

transactions and, second, deregulation

within the financial systems of the

major industrial nations

Assets denominated in various

currencies became more nearly

substitutable


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Recent Changes in GlobalFinancial Markets (contd.)

Deregulation involved action on twofronts

Eliminating the segmentation of the

markets for financial services permitting foreign financial institutions to

enter the national markets and competeon an equal footing with the domestic

institutions

This is a part of the overall trendtowards securitization and

disintermediation


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Recent changes in GlobalFinancial Markets (contd.)

The attainment of the Economic andMonetary Union (EMU) and the birth of

Euro in the closing years of the decadeof 1990's

There is a race on to come up with

increasingly complex and oftenesoteric products which, it issometimes said, the bankers

themselves do not fully understand


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Advent of Euroref: PK jain & peryard

International Capital market known asEuro market.

Euro market is the market where Eurocurrencies, Bonds, shares and bills aretraded.

Euro currency is the currency wheredeposits are made out side theterritory of the origin of that currency.


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Euro Bank is the bank where Eurocurrencies are deposited.

Euro credit market: participants- EuroBanks , American, Japanese, British,Swiss, French, German, and Asian

(Singapore) Chemical banks,JPMorgan, Citicorp, Banker Trust,Chase Manhattan Bank Etc.


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Interest rate is calculated with respectto a rate of reference increased by a

margin. Fixed with reference to LIBOR LIBOR is the rate of money market

applicable to short term credits among

the banks of London.


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Difference between Euro

credit and Euro Bond. Cost of Borrowing:EC carry variable rate- EB

carry both fixed and Floating rate.

Maturity: EC depends on the timeEB haslonger maturity.

Size of the Issue: EC lower than EB.

Flexibility: EC with a multicurrency clausecan switch over to any currency. EB switchover is costly.


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International Monetary System


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International Monetary SystemIntroduction

The International Monetary System facilitatestransfer of funds between parties, conversionof national currencies into one another,acquisition and liquidation of financial assets,

and international credit creation

An important constituent of the globalfinancial system


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Introduction (contd.)

The relevant aspects of the system

Exchange rate regimes, current and past

International liquidity

The International Monetary Fund

The adjustment process i.e. how doesthe system facilitate the process ofcoping with payments imbalances

between trading nations Currency blocks and unions such as the

EMU


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Exchange Rate Regimes


The IMF classifies member countries into eightcategories

Currency Union (No separate legal tender)

Currency Board Arrangement

Conventional Fixed Peg Arrangements

Pegged Exchange Rates within Horizontal Bands

Crawling Peg

Crawling bands Managed float

Independent float

E h R t R i A Hi t i l


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Exchange Rate Regimes: A HistoricalPerspective

The Gold Standard

Gold Specie Standard; Gold Bullion StandardGold ExchangeStandard

Mint Parity: The exchange rate between any pairof currencies will be determined by their respective

exchange rates against goldThe gold standard regime imposes very rigiddiscipline on the policy makers :

The money supply in the country must be tied to theamount of gold the monetary authorities have inreserve.When a country loses gold, money supplymust contract.

Domestic economy governed by external sector.


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Exchange Rate Regimes: History The Bretton Woods System

The exchange rate regime that was put in placeafter WWII can be characterized as GoldExchange Standard

The US government undertook to convert the

US dollar freely into gold at a fixed parity of$35 per ounce

Other member countries of the IMF agreed tofix the parities of their currencies with thedollar with variation within 1% on either side of

the central parity being permissibleIt was anAdjustable Pegsystem. Central parity could be

changed in the face of fundamental disequilibrium.


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Exchange Rate Regimes: History In return for undertaking this obligation,

the member countries were entitled toborrow from the IMF to carry out theirintervention in the currency markets

Whenever the exchange rate tended to

move out of the 1% band, the centralbank had to sell or buy the foreigncurrency to bring it back within the band.Devaluation/up valuation when

disequilibrium persistedFundamentalDisequilibrium


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Exchange Rate Regimes: History

Intervention operations affect the domestic

money supply and then the price level, GNPetc.

These effects may have an automatic

corrective effectCentral bank sells forex,money supply contracts, price level reduces,GNP reduces, imports decline, the pressureon home currency reduces.

Central bank can sterilize these effects.


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Exchange Rate Regimes: History

This system could work as long as other countries

had confidence in the stability of the US dollar andin the ability of the US treasury to convert dollarsinto gold on demand at the specified conversionrate

The system came under pressure and ultimatelybroke down when this confidence was shaken dueto various political and some economic factorsstarting in mid 1960s.

Abandoned in 1973 after some attempts to fix it

and revive it. Major currencies started floating in early 1973.


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E h R R i


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One school of thought feels there will be

only two types of exchange rate regimesTruly fixed rate arrangements

Truly market determined, floating rates

The impossible trinity : A country can

achieve any two of the following three policygoals but not all threeA stable exchange rate

Monetary policy independence

Financial market integration with rest of the world

Th I t ti l M t F d


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The International Monetary Fund(IMF)

The role of IMF Framework of the Articles of Agreement adoptedat Bretton Woods in1944

Increasing international monetary cooperation

Promoting the growth of trade

Promoting exchange rate stability

Establishing a system of multilateral payments,eliminating exchange restrictions which hamperthe growth of world trade and encouraging

progress towards convertibility of membercurrencies

Building a reserve base

Th I t ti l M t F d


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Th I t ti l M t F d


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The International Monetary Fund Special Drawing Rights (SDRs)

SDR is international fiat money created by IMFand allocated to member countries.

Can be used by Central banks to settlepayments among themselves. Selected other

institutions allowed to hold and use SDRs In order to make SDRs an attractive asset to

hold, the Fund pays interest on holdings inexcess of a member's cumulative allocation andit charges interest on any shortfalls

Have not become popular as reserve asset


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The International Monetary Fund

The Role of IMF in the Post-Bretton Woods

World Under the Bretton Woods system the IMF was

responsible for the functioning of the adjustablepeg system

Under the current "non-system" that role hasconsiderably diminished if not eliminated

The Fund is mandated to "exercise firmsurveillance over the exchange rate policies of

members" The Fund has played an important role in tackling

the debt crisis of developing countries


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EMU Hi t


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EMU: History

Monetary Union had beenenvisaged as apart of the move towards creating a singleeconomic zone in Europe

Just when it appeared that Europe willsteadily march towards an economic andmonetary union as envisaged in the"Maastricht treaty", the system receivedsevere jolts

"Growth and Stability Pact" in 1996

The single currency "Euro" came intoexistence on January 1 1999


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The Economic and Monetary Union

After 2002, their individual currencies willcease to exist

The parities of the eleven member currencies

against each other and against the Euro wereirrevocably fixed when Euro was born.

At the start 1 Euro = 1 ECU

The EMU and the Euro provide a model forother currency unions


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How?

BOP is kept on a double entry system

of bookkeeping. E.g. if exports are made, there will be

a credit for outflow of goods on

current account and a correspondingentry of debit for claim on foreigners.

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