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MB0053 - International Business Management - Set 1

MB0053 - International Business Management - Set 1

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SIKKIM MANIPAL UNIVERSITY DEPARTMENT OF DISTANCE EDUCATION

ASSIGNMENT SEMESTER 4

NAME ROLL NUMBER LEARNING CENTER SUBJECT NAME MODULE NO DATE OF SUBMISSION AT THE LEARNING CENTRE FACULTY SIGNATURE

: : : : : : :

ABHISHEK JAIN 511035358 02882

INTERNATIONAL BUSINESS MANAGEMENT (MB0053) SET 1 31-MAY-11

MBA 4th Sem Assignment

International Business Management – MB0053 – Set 1

Master of Business Administration-MBA Semester 4 International Business Management – MB0053
Assignment Set - 1
Q.1 What is globalization? What are its benefits? How does globalization help in international business? Give some instances? Ans : Globalization (or globalisation) describes the process by which regional economies, societies, and cultures have become integrated through a global network of political ideas through communication, transportation, and trade. The term is most closely associated with the term economic globalization: the integration of national economies into the international economy through trade, foreign direct investment, capital flows, migration, the spread of technology, and military presence. However, globalization is usually recognized as being driven by a combination of economic, technological, sociocultural, political, and biological factors. The term can also refer to the transnational circulation of ideas, languages, or popular culture through acculturation. An aspect of the world which has gone through the process can be said to be globalized. Against this view, an alternative approach stresses how globalization has actually decreased intercultural contacts while increasing the possibility of international and intra-national conflict.[3] Globalization has various aspects which affect the world in several different ways  Industrial - emergence of worldwide production markets and broader access to a range of foreign products for consumers and companies. Particularly movement of material and goods between and within national boundaries. International trade in manufactured goods increased more than 100 times (from $95 billion to $12 trillion) in the 50 years since 1955.China's trade with Africa rose sevenfold during 2000-07 alone.  Financial - emergence of worldwide financial markets and better access to external financing for borrowers. By the early part of the 21st century more than $1.5 trillion in national currencies were traded daily to support the expanded levels of trade and investment  Economic - realization of a global common market, based on the freedom of exchange of goods and capital  Job Market- competition in a global job market. In the past, the economic fate of workers was tied to the fate of national economies. With the advent of the information age and improvements in communication, this is no longer the case. Because workers compete in a global market, wages are less dependent on the success or failure of individual economies. This has had a major effect on wages and income distribution  Political - some use "globalization" to mean the creation of a world government which regulates the relationships among governments and guarantees the rights arising from social and economic globalization. Politically, the United States has enjoyed a position of power among the world powers, in part because of its strong and wealthy economy. With the influence of globalization and with the help of the United States’ own economy, the People's Republic of China has experienced some tremendous growth within the past decade. If China continues to grow at the rate projected by the trends, then it is very likely that in the next twenty years, there will be a major reallocation of power among the world leaders. China will have enough wealth, industry, and technology to rival the United States for the position of leading world power. Most of us assume that international and global business are the same and that any company that deals with another country for its business is an international or global company. In fact, there is a considerable difference between the two terms. International companies – Companies that deal with foreign companies for their business are considered as international companies. They can be exporters or importers who may not have any investments in any other country, apart from their home country. Global companies – Companies, which invest in other countries for business and also operate from other countries, are considered as global companies. They have multiple manufacturing plants across the globe, catering to multiple markets. The transformation of a company from domestic to international is by entering just one market or a few selected foreign markets as an exporter or importer. Competing on a truly global scale comes later, after the company has established operations in several countries across continents and is racing against rivals for global market leadership. Thus, there is a meaningful distinction between a company that operates in few selected foreign countries and a company that operates and 2011 Abhishek Jain - 511035358 Page 2 of 19

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International Business Management – MB0053 – Set 1

markets its products across several countries and continents with manufacturing capabilities in several of these countries. Companies can also be differentiated by the kind of competitive strategy they adopt while dealing internationally. Multinational strategy and global competitive strategy are the two types of competitive strategy.  Multinational strategy – Companies adopt this strategy when each country’s market needs to be treated as self contained. It can be for the following reasons: o Customers from different countries have different preferences and expectations about a product or a service. o Competition in each national market is essentially independent of competition in other national markets, and the set of competitors also differ from country to country. o A company’s reputation, customer base, and competitive position in one nation have little or no bearing on its ability to successfully compete in another nation. o Some of the industry examples for multinational competition include beer, life insurance, and food products.  Global competitive strategy – Companies adopt this strategy when prices and competitive conditions across the different country markets are strongly linked together and have common synergies. In a globally competitive industry, a company’s business gets affected by the changing environments in different countries. The same set of competitors may compete against each other in several countries. In a global scenario, a company’s overall competitive advantage is gauged by the cumulative efforts of its domestic operations and the international operations worldwide. A good example to illustrate is Sony Ericsson, which has its headquarters in Sweden, Research and Development setup in USA and India, manufacturing and assembly plants in low wage countries like China, and sales and marketing worldwide. This is made possible because of the ease in transferring technology and expertise from country to country. Industries that have a global competition are automobiles, consumer electronics (like televisions, mobile phone), watches, and commercial aircraft and so on. Table 1 portrays the differences in strategies adopted by companies in international and global operations. Table 1: Differences between International and Global Strategies Strategy International Global Location Selected target countries and Most global businesses operate in North America, trading areas Europe, Asia Pacific, and Latin America Business Custom strategies to fit the Same basic strategy worldwide with minor country circumstances of each host customisation where necessary country situation Product-line Adopted to local culture and Mostly standardised products sold worldwide, particular needs and expectations moderate customisation depending on the of local buyers regulatory framework Production Plants scattered across many host Plants located on the basis of maximum competitive countries, each producing advantage (in low cost countries close to major versions suitable for the markets, geographically scattered to minimise surrounding environment shipping costs, or use of a few world scale plants to maximise economies of scale) Source of supply Suppliers in host country preferred Attractive suppliers from across the world of raw materials Marketing and Adapted to practices and culture Much more worldwide coordination; minor distribution of each host country adaptation to host country situations if required Cross country Efforts made to transfer ideas, Efforts made to use almost the same technologies, connections technologies, competencies and competencies, and capabilities in all country capabilities that work successfully markets (to promote use of a mostly standard in one country to another country strategy), new successful competitive capabilities whenever such a transfer appears are transferred to different country markets advantageous Company Form subsidiary companies to All major strategic decisions closely coordinated at organisation handle operations in each host global headquarters; a global organisational 2011 Abhishek Jain - 511035358 Page 3 of 19

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country; each subsidiary operates structure is used to unify the operations in each more or less autonomously to fit country host country conditions Benefits of globalisation We have moved from a world where the big eat the small to a world where the fast eat the slow", as observed by Klaus Schwab of the Davos World Economic Forum. All economic analysts must agree that the living standards of people have considerably improved through the market growth. With the development in technology and their introduction in the global markets, there is not only a steady increase in the demand for commodities but has also led to greater utilization. Investment sector is witnessing high infusions by more and more people connected to the world's trade happenings with the help of computers. As per statistics, everyday more than $1.5 trillion is now swapped in the world's currency markets and around one-fifth of products and services are generated per year are bought and sold. Buyers of products and services in all nations comprise one huge group who gain from world trade for reasons encompassing opportunity charge, comparative benefit, economical to purchase than to produce, trade's guidelines, stable business and alterations in consumption and production. Compared to others, consumers are likely to profit less from globalization. Another factor which is often considered as a positive outcome of globalization is the lower inflation. This is because the market rivalry stops the businesses from increasing prices unless guaranteed by steady productivity. Technological advancement and productivity expansion are the other benefits of globalization because since 1970s growing international rivalry has triggered the industries to improvise increasingly. Globalization can be described as a process by which the people of the world are unified into a single society and functioning together. This process is a combination of economic, technological, sociocultural and political forces. Globalization, as a term, is very often used to refer to economic globalization, that is integration of national economies into the international economy through trade, foreign direct investment, capital flows, migration, and spread of technology. The word globalization is also used, in a doctrinal sense to describe the neoliberal form of economic globalization.Globalization is also defined as internationalism, however such usage is typically incorrect as "global" implies "one world" as a single unit, while "international" (between nations) recognizes that different peoples, cultures, languages, nations, borders, economies, and ecosystems exist(http://en.wikipedia.org/). Globalization has two components: the globalization of market and globalization of production.... Some other benefits of globalization as per statistics  Commerce as a percentage of gross world product has increased in 1986 from 15% to nearly 27% in recent years.  The stock of foreign direct investment resources has increased rapidly as a percentage of gross world product in the past twenty years.  For the purpose of commerce and pleasure, more and more people are crossing national borders. Globally, on average nations in 1950 witnessed just one overseas visitor for every 100 citizens. By the mid-1980s it increased to six and ever since the number has doubled to 12.  Worldwide telephone traffic has tripled since 1991. The number of mobile subscribers has elevated from almost zero to 1.8 billion indicating around 30% of the world population. Internet users will quickly touch 1 billion. o Promotes foreign trade and liberalisation of economies. o Increases the living standards of people in several developing countries through capital investments in developing countries by developed countries. o Benefits customers as companies outsource to low wage countries. Outsourcing helps the companies to be competitive by keeping the cost low, with increased productivity. o Promotes better education and jobs. o Leads to free flow of information and wide acceptance of foreign products, ideas, ethics, best practices, and culture. o Provides better quality of products, customer services, and standardised delivery models across countries. o Gives better access to finance for corporate and sovereign borrowers. o Increases business travel, which in turn leads to a flourishing travel and hospitality industry across the world. 2011 Abhishek Jain - 511035358 Page 4 of 19

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Increases sales as the availability of cutting edge technologies and production techniques decrease the cost of production. o Provides several platforms for international dispute resolutions in business, which facilitates international trade. Some of the ill-effects of globalisation are as follows:  Leads to exploitation of labour in several cases.  Causes unemployment in the developed countries due to outsourcing.  Leads to the misuse of IPR, copyrights and so on due to the easy availability of technology, digital communication, travel and so on.  Influences political decisions in foreign countries. The MNCs increasingly use their economical powers to influence political decisions.  Causes ecological damage as the companies set up polluting production plants in countries with limited or no regulations on pollution.  Harms the local businesses of a country due to dumping of cheaper foreign goods.  Leads to adverse health issues due to rapid expansion of fast food chains and increased consumption of junk food.  Causes destruction of ethnicity and culture of several regions worldwide in favour of more accepted western culture. In spite of its disadvantages, globalisation has improved our lives in various fields like communication, transportation, healthcare, and education. Q.2 What is culture and in the context of international business environment how does it impact international business decisions? Ans: Culture is defined as the art and other signs or demonstrations of human customs, civilisation, and the way of life of a specific society or group. Culture determines every aspect that is from birth to death and everything in between it. It is the duty of people to respect other cultures, other than their culture. Research shows that national ‘‘cultures’’ generally characterise the dominant groups’ values and practices in society, and not of the marginalised groups, even though the marginalised groups represent a majority or a minority in the society. Culture is very important to understand international business. Culture is the part of environment, which human has created, it is the total sum of knowledge, arts, beliefs, laws, morals, customs, and other abilities and habits gained by people as part of society. Culture is an important factor for practising international business. Culture affects all the business functions ranging from accounting to finance and from production to service. This shows a close relation between culture and international business. The following are the four factors that question assumptions regarding the impact of global business in culture:  National cultures are not homogeneous and the impact of globalisation on heterogeneous cultures is not easily predicted.  Culture is not similar to cultural practice.  Globalisation does not characterise a rupture with the past but is a continuation of prior trends.  Globalisation is only one of many processes involved in cultural change. Cultural differences affect the success or failure of multinational firms in many ways. The company must modify the product to meet the demand of the customers in a specific location and use different marketing strategy to advertise their product to the customers. Adaptations must be made to the product where there is demand or the message must be advertised by the company. The following are the factors which a company must consider while dealing with international business:  The consumers across the world do not use same products. This is due to varied preferences and tastes. Before manufacturing any product, the organisation has to be aware of the customer choice or preferences.  The organisation must manage and motivate people with broad different cultural values and attitudes. Hence the management style, practices, and systems must be modified.  The organisation must identify candidates and train them to work in other countries as the cultural and corporate environment differs. The training may include language training, corporate training, training them on the technology and so on, which help the candidate to work in a foreign environment.

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The organisation must consider the concept of international business and construct guidelines that help them to take business decisions, and perform activities as they are different in different nations. The following are the two main tasks that a company must perform: o Product differentiation and marketing – As there are differences in consumer tastes and preferences across nations; product differentiation has become business strategy all over the world. The kinds of products and services that consumers can afford are determined by the level of per capita income. For example, in underdeveloped countries, the demand for luxury products is limited. o Manage employees – It is said that employees in Japan were normally not satisfied with their work as compared with employees of North America and European countries; however the production levels stayed high. To motivate employees in North America, they have come up with models. These models show that there is a relation between job satisfaction and production. This study showed the fact that it is tough for Japanese workers to change jobs. While this trend is changing, the fact that job turnover among Japanese workers is still lower than the American workers is true. Also, even if a worker can go to another Japanese entity, they know that the management style and practices will be quite alike to those found in their present firm. Thus, even if Japanese workers were not satisfied with the specific aspects of their work, they know that the conditions may not change considerably at another place. As such, discontent might not impact their level of production. The following are the three mega trends in world cultures:  The reverse culture influence on modern Western cultures from growing economies, particularly those with an ancient cultural heritage.  The trend is Asia centric and not European or American centric, because of the growing economic and political power of China, India, South Korea, and Japan and also the ASEAN.  The increased diversity within cultures and geographies.  The following are the necessary implications in international business:  Avoid self reference criterion such as, one’s own upbringing, values and viewpoints.  Follow a philosophical viewpoint that considers that many perspectives of a single observation or phenomenon can be true.  Discover and identify global segments and global niche markets, as national markets are diverse with growing mobility of products, people, capital, and culture.  Grow the total share market by innovating affordable products and services, and making them accessible so that, they are affordable for even subsistence level consumers rather than fighting for market share.  Organise global enterprises around global centres of excellence. Hofstede’s cultural dimensions According to Dr. Geert Hofstede, ‘Culture is more often a source of conflict than of synergy. Cultural differences are a trouble and always a disaster.’ Professor Hofstede carried out a detailed study of how values in the workplace are influenced by culture. He worked as a psychologist in IBM from 1967 to 1973. At that time he gathered and analysed data from many people from several countries. Professor Hofstede established a model using the results of the study which identifies four dimensions to differentiate cultures. Later, a fifth dimension called ‘long-term outlook’ was added. The following are the five cultural dimensions:  Power Distance Index (PDI) – This focuses on the level of equality or inequality, between individuals in the nation’s society. A country with high power distance ranking depicts that inequality of power and wealth has been allowed to grow within the society. These societies follow caste system that does not allow large upward mobility of its people. A country with low power distance ranking depicts the society and de-emphasises the differences between its people’s power and wealth. In these societies equality and opportunity is stressed for everyone.  Individualism – This dimension focuses on the extent to which the society reinforces individual or collective achievement and interpersonal relationships. A high individualism ranking depicts that individuality and individual rights are dominant within the society. Individuals in these societies form a larger number of looser relationships. A low individualism ranking characterises societies of a more collective nature with close links between individuals. These cultures support extended families and collectives where everyone takes responsibility for fellow members of their group.  Masculinity – This focuses on the extent to which the society supports or discourages the traditional masculine work role model of male achievement, power, and control. A country with high masculinity ranking shows the country experiences high level of gender differentiation. In 2011 Abhishek Jain - 511035358 Page 6 of 19

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these cultures, men dominate a major part of the society and power structure, with women being controlled and dominated by men. A country with low masculinity ranking shows the country, having a low level of differentiation and discrimination between genders. In low masculinity cultures, women are treated equal to men in all aspects of the society.  Uncertainty Avoidance Index (UAI) – This focuses on the degree of tolerance for uncertainty and ambiguity within the society that is unstructured situations. A country with high uncertainty avoidance ranking shows that the country has low tolerance for uncertainty and ambiguity. A rule-oriented society that incorporates rules, regulations, laws, and controls is created to minimise the amount of uncertainty. A country with low uncertainty avoidance ranking shows that the country has less concern about ambiguity and uncertainty and has high tolerance for a variety of opinions. A society which is less rule-oriented, readily agrees to changes, and takes greater risks reflects a low uncertainty avoidance ranking.  Long-Term Orientation (LTO) – Describes the range at which a society illustrates a pragmatic future oriented perspective instead of a conventional historic or short term point of view. The Asian countries are scoring high on this dimension. These countries have a long term orientation, believe in many truths, accept change easily, and have thrift for investment. Cultures recording little on this dimension, trust in absolute truth is conventional and traditional. They have a small term orientation and a concern for stability. Many western cultures score considerably low on this dimension. In India, PDI is the highest Hofstede dimension for culture with a rank of 77, LTO dimension rank is 61, and masculinity dimension rank is 62. Every society has its own unique culture. Culture must not be imposed on individuals of different culture. For example, the Cadbury Kraft Acquisition, 2009 was a landmark international deal, in which a U.S. based company Kraft acquired the British chocolate giant, Cadbury which were in complete extremes in terms of culture. Let us discuss the major cultural elements that are related to business. Cultural elements that relate business The most important cultural components of a country which relate business transactions are:  Language.  Religion.  Conflicting attitudes. Cross cultural management is defined as the development and application of knowledge about cultures in the practice of international management, when people involved have diverse cultural identities. International managers in senior positions do not have direct interaction that is face-to-face with other culture workforce, but several home based managers handle immigrant groups adjusted into a workforce that offers domestic markets. The factors to be considered in cross cultural management are: Cross cultural management skills The ability to demonstrate a series of behaviour is called skill. It is functionally linked to achieving a performance goal. The most important aspect to qualify as a manager for positions of international responsibility is communication skills. The managers must adapt to other culture and have the ability to lead its members. The managers cannot expect to force members of other culture to fit into their cultural customs, which is the main assumption of cross cultural skills learning. Any organisation that tries to enforce its behavioural customs on unwilling workers from another culture faces conflict. The manager has to possess the skills linked with the following:  Providing inspiration and appraisal systems.  Establishing and applying formal structures.  Identifying the importance of informal structures.  Formulating and applying plans for modification.  Identifying and solving disagreements. Handling cultural diversity Cultural diversity in a work group offers opportunities and difficulties. Economy is benefited when the work groups are managed successfully. The organisation’s capability to draw, save, and inspire people from diverse cultures can give the organisation spirited advantages in structures of cost, creativity, problem solving, and adjusting to change. 2011 Abhishek Jain - 511035358 Page 7 of 19

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Cultural diversity offers key chances for joint work and co-operative action. Group work is a joint venture where, the production of two or more individuals or groups working in cooperation is larger than the combined production of their individual work. Factors controlling group creativity On complicated problem solving jobs diverse groups do better than identical groups. Diverse groups require time to solve issues of working together. In diverse groups, over time, the work experience helps to overcome gender, racial, and organisational and functional discriminations. But the impact cannot be evaluated and there is always risk in creating a diverse group. A successful group is profitable with respect to quick results and the creation of concern for the future. Negative stereotypes are emphasised if it fails. Factors related with the industry and company culture are also important. Diverse groups do well when the members: o Assist to make group decisions. o Value the exchange of different points of view. o Respect each other’s skills and share their own. o Value the chance for cross-cultural learning. o Tolerate uncertainty and try to triumph over the inefficiencies that occur when members of diverse cultures work together. A diverse group is known to be more creative, where the members are tolerant of differences. The top management level provides its moral and administrative support, and gives time for the group to overcome the usual process difficulties. They also provide diversity training, and the group members are rewarded for their commitment. Ignore diversity It may be difficult to manage diversity. It is better to ignore, which is an alternative. The management must: o Ignore cultural diversity within the employees. o Down-play the importance of cultural diversity. This rejection to identify diversity happens when management: o Fails to have sufficient awareness and skills to identify diversity. o Identifies diversity but does not have the skill to manage the diversity. o Recognises the negative consequences of identifying diversity probably cause greater issues than ignoring it. o Thinks the likely benefits of identifying and managing diversity do not validate the expected expenses. o Identifies that the job provides no chances for drawing advantages from diversity. Strategies to ignore diversity may be possible when culture groups are given various jobs, and sharing required resources are independent in the workplace. Groups and group members are equally incorporated and work together. In such cases, confusion occurs when the diverse value systems are not identified that are held by different staff groups. Q3. Cosmos Limited wants to enter international markets. Will country risk analysis help Cosmos Limited to take correct decisions? Substantiate your answer Ans: Country risk analysis is the evaluation of possible risks and rewards from business experiences in a country. It is used to survey countries where the firm is engaged in international business, and avoids countries with excessive risk. With globalisation, country risk analysis has become essential for the international creditors and investors Overview of Country Risk Analysis Country Risk Analysis (CRA) identifies imbalances that increase the risks in a cross-border investment. CRA represents the potentially adverse impact of a country’s environment on the multinational corporation’s cash flows and is the probability of loss due to exposure to the political, economic, and social upheavals in a foreign country. All business dealings involve risks. An increasing number of companies involving in external trade indicate huge business opportunities and promising markets. Since the 1980s, the financial markets are being refined with the introduction of new products. When business transactions occur across international borders, they bring additional risks compared to those in domestic transactions. These additional risks are called country risks which include risks arising from national differences in socio-political institutions, economic structures, policies, currencies, and geography. The CRA monitors the potential for these risks to decrease the expected return of a cross-border investment. For example, a multinational enterprise (MNE) that sets up a 2011 Abhishek Jain - 511035358 Page 8 of 19

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plant in a foreign country faces different risks compared to bank lending to a foreign government. The MNE must consider the risks from a broader spectrum of country characteristics. Some categories relevant to a plant investment contain a much higher degree of risk because the MNE remains exposed to risk for a longer period of time. Analysts have categorised country risk into following groups:  Economic risk – This type of risk is the important change in the economic structure that produces a change in the expected return of an investment. Risk arises from the negative changes in fundamental economic policy goals (fiscal, monetary, international, or wealth distribution or creation).  Transfer risk – Transfer risk arises from a decision by a foreign government to restrict capital movements. It is analysed as a function of a country’s ability to earn foreign currency. Therefore, it implies that effort in earning foreign currency increases the possibility of capital controls.  Exchange risk – This risk occurs due to an unfavourable movement in the exchange rate. Exchange risk can be defined as a form of risk that arises from the change in price of one currency against another. Whenever investors or companies have assets or business operations across national borders, they face currency risk if their positions are not hedged.  Location risk – This type of risk is also referred to as neighborhood risk. It includes effects caused by problems in a region or in countries with similar characteristics. Location risk includes effects caused by troubles in a region, in trading partner of a country, or in countries with similar perceived characteristics.  Sovereign risk – This risk is based on a government’s inability to meet its loan obligations. Sovereign risk is closely linked to transfer risk in which a government may run out of foreign exchange due to adverse developments in its balance of payments. It also relates to political risk in which a government may decide not to honor its commitments for political reasons.  Political risk – This is the risk of loss that is caused due to change in the political structure or in the politics of country where the investment is made. For example, tax laws, expropriation of assets, tariffs, or restriction in repatriation of profits, war, corruption and bureaucracy also contribute to the element of political risk. Risk assessment requires analysis of many factors, including the decision-making process in the government, relationships of various groups in a country and the history of the country. Country risk is due to unpredicted events in a foreign country affecting the value of international assets, investment projects and their cash flows. The analysis of country risks distinguishes between the ability to pay and the willingness to pay. It is essential to analyse the sustainable amount of funds a country can borrow. Country risk is determined by the costs and benefits of a country’s repayment and default strategies. The ways of evaluating country risks by different firms and financial institutions differ from each other. The international trade growth and the financial programs development demand periodical improvement of risk methodology and analysis of country risks. Purpose of Country Risk Analysis Risk arises because of uncertainty and uncertainty occurs due to the lack of reliable information. Country risk is composed of all the uncertainty that defines the risk of country exposure. The assessment of country risk is used to incorporate country risk in capital budgeting and modify the discount rate. CRA regulates the estimated cash flows and explores the main techniques used to measure a country’s overall riskiness. It is mainly used by MNCs, in order to avoid countries with excessive risk. It can be used to monitor countries where the MNC is engaged in international business. Analysing the country risk helps in evaluating the risk for a planned project considered for a foreign country and assesses gain and loss possibility outcomes of cross-border investment or export strategy. Country detailed risk refers to the unpredictability of returns on international business transactions in view of information associated with a particular country. The techniques used by the banks and other agencies for country risk analysis can be classified as qualitative or quantitative. Many agencies merge both qualitative and quantitative information into a single rating. A survey conducted by the US EXIM bank classified the various methods of country risk assessment used by the banks into four types. They are:  Fully qualitative method – The fully qualitative method involves a detailed analysis of a country. It includes general discussion of a country’s economic, political, and social conditions and prediction. Fully qualitative method can be adapted to the unique strengths and problems of the country undergoing evaluation.  Structured qualitative method – The structured method uses a uniform format with predetermined scope. In structured qualitative method, it is easier to make comparisons between countries as it 2011 Abhishek Jain - 511035358 Page 9 of 19

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follows a specific format across countries. This technique was the most popular among the banks during the late seventies.  Checklist method – The checklist method involves scoring the country based on specific variables that can be either quantitative, in which the scoring does not need personal judgment of the country being scored or qualitative, in which the scoring needs subjective determinations. All items are scaled from the lowest to the highest score. The sum of scores is then used to determine the country risk.  Delphi technique – The technique involves a set of independent opinions without group discussion. As applied to country risk analysis, the MNC can assess definite employees who have the capability to evaluate the risk characteristics of a particular country. The MNC gets responses from its evaluation and then may determine some opinions about the risk of the country.  Inspection visits – Involves travelling to a country and conducting meeting with government officials, business executives, and consumers. These meetings clarify any vague opinions the firm has about the country.  Other quantitative methods – The quantitative models used in statistical studies of country risk analysis can be classified as discriminant analysis, principal component analysis, logit analysis and classification and regression tree method Data sourcing The basic data is important to analyse a country. The economic, financial and currency risk components are based on the variables (quantitative and qualitative variables). The variables must consider the particularities of each country and the needs of the model used. The standard variables are used to maintain the regular analysis comparable with similar works of other countries. Therefore, the first step is to make sure that the historical series of official data are reliable, consistent and comparable. The standard economic variables that are found mainly in the varied approach adopted by financial institutions and rating agencies, are associated with the country’s real ability to repay its commitments. The balance of payments (summary account of economic transactions among a country and the others nations of the world, during a period) and its evolution through the years means a strong source of data. The exchange rate (currency risk) is another important variable considered, as it balances the transactions (balances the prices of goods, services, and capital) between residents and non-residents. The analysis must consider the historical behavior of the exchange rate and the policy which made clear whether the country follows a rational economics approach or it uses the exchange rate as a tool to maintain a forced macroeconomic equilibrium. Apart from the macroeconomic variables which deal with the external sector of the economy, there are some other relevant variables such as the interest rate, level of investments, public debt and its service, internal savings, consumption, GDP or GNP, money supply, inflation rate and so on. The analysis must be accomplished with qualitative variables, which consider social aspects as population, life expectancy, rate of birthday, rate of unemployment, level of literacy and so on. The social-political aspects are necessary for all kind of analysis as they describe the whole setting of the running economy. Tools The risk management demands a regular follow up regarding governmental policies, external and internal environment, outlook provided by rating agencies, and so on. Following are the tools recommended:  Chain of value – Includes the main countries that sustain trade relationships with the nation, broken by sectors and products.  Strength and weakness chart – Focus the key aspects that warn the country.  Table of financial markets performance – Follow up the behavior of bonds and stocks already issued and to be issued.  Table of macroeconomic variables – Provides alert signals when the behavior of any ratio presents a relevant change. The content of country risk analysis mainly involves country history, corporate risk, dependency level, external environment, domestic financial system, ratios for economic risk evaluation and strength and weakness chart. Country history The historical brief helps to identify aspects that interfere in the future behavior of the country, reducing the ability to payback any external commitment. The main historical data provides a good understanding of the key factors which draw the behaviour of the society, the government, the private sector, the legal environment, the economical, political, and the relationships to neighbour nations and the world as a whole. 2011 Abhishek Jain - 511035358 Page 10 of 19

MBA 4th Sem Assignment

International Business Management – MB0053 – Set 1

Corporate risk Both country risk studies and business risk analysis enhances wealth from the available resources, in terms of capital, natural resources, technology and labour forces. This clarifies that those kind of analysis procures extensive knowledge from the business approach for companies, including financial theory. Dependency level The next step after the history in brief, is a clear definition about how the country is positioned in the world in terms of its wide relationships, economic block in which it belongs to, importance of international trade and so on. All these aspects are significant to identify the dependency level of the country. The financial dependency to meet the needs of a country is also a strong concern for the analyst. In this case, the maturity of debts (internal and external) and the available sources of financing also help to measure the freedom grades of the country. External environment The external trade is an important factor to the development of societies. Globalisation has brought international business to the center of the discussions and the external environment has become vital for all countries. Thus, a complete vision on economic trends, the behavior of financial markets, the forecasts for conflicts among nations, the improvement of the economic blocks, the level of openness of the world economy, financial crisis and international liquidity is a framework over which the analysis must start. Domestic financial system The banking sector has implemented many actions to avoid losses, after the international crisis. Basel Committee has defined some strong measures to be followed by the financial houses and Central Banks are trying to monitor their jurisdictions. Apart from those procedures, recently Asia and Turkey crisis have shown that the inspection is not enough to keep the reliability of some domestic system. The international banks had developed many tools to deal with international crisis. When domestic banks do not have a consistent risk management policies and adequate provisions to theirs credits, the country risk happens to be the worst. Therefore, the analysis must consider the health of the domestic financial system, by evaluating information provided by the Central Banks and, from the principal banks of the country. Accessing Centrals Bank policies and supervising procedures also help to evaluate the health of the financial system. Ratios for economic risk evaluation Cross-border economic risk analysis evaluates the probable macroeconomic ratios among some variables. They can be separated into two groups such as domestic and external. The figures must be presented in historic series (at least five years) to provide information about its progress, which can be real values, percentages, or relations. The mainly used ratios and variables in case of domestic economy are the following: · Gross domestic product (GDP) –· GDP per capita –· GDP growth rate –· Unemployment rate –· Internal savings or GDP –· Investment or GDP –· Gross domestic fixed investment or variation of GDP – Gini Index –· Growth domestic fixed investment or gross domestic savings –.· Budget deficit or GDP –· Internal debt or GDP – The monetary policy is essential as it deals with the price stability. An economy which presents less instability in its prices of goods and services, provides huge facilities to decision makers based on their predictions to expected returns of investments and a firm social, economical and political environment. All these aspects request a systematic approach over price indicators such as the following: · Real interest rate –· Percentage increase in the money supply The mainly used ratios and variables in case of external economy are the following: · External debt or GDP –· Short term debts and reserves –· Exchange currency rate –· External debt services and exports –. Strength and weakness chart In order to explain the significant aspects provided by the analysis, the strength and weakness chart can be used to merge each strength and weakness with the related scenario. is a model of relationships among several variables (quantitative and qualitative) to show their interdependency and the complexity of analysis. Q4. How can managers in international companies adjust to the ethical factors influencing countries? Is it possible to establish international ethical codes? Briefly explain? 2011 Abhishek Jain - 511035358 Page 11 of 19

MBA 4th Sem Assignment

International Business Management – MB0053 – Set 1

Ans: Ethics can be defined as the evaluation of moral values, principles, and standards of human conduct and its application in daily life to determine acceptable human behaviour. Business ethics pertains to the application of ethics to business, and is a matter of concern in the corporate world. Business ethics is almost similar to the generally accepted norms and principles. Behaviour that is considered unethical and immoral in society, for example dishonesty, applies to business as well. Managers are influenced by three factors affecting ethical values. These factors have unique value systems that have varying degrees of control over managers. Religion – Religion is one of the oldest factors affecting ethics. Despite the differences in religious teachings, religions agree on the fundamental principles and ethics. All major religions preach the need for high ethical standards, an orderly social system, and stress on social responsibility as contributing factors to general well-being. Culture – Culture refers to a set of values and standards that defines acceptable behaviour passed on to generations. These values and standards are important because the code of conduct of people reflects on the culture they belong to. Civilisation is the collective experience that people have passed on through three distinct phases: the hunting and gathering phase, agriculture phase, and the industrial phase. These phases reflect the changing economic and social arrangements in human history. Law – Law refers to the rules of conduct, approved by the legal system of a country or state that guides human behaviour. Laws change and evolve with emerging and changing issues. Every organisation is expected to abide the law, but in the pursuit of profit, laws are frequently violated. The most common breach of law in business is tax evasion, producing inferior quality goods, and disregard for environmental protection laws. Ethics is significant in all areas of business and plays an important role in ensuring a successful business. The role of business ethics is evident from the conception of an idea to the sale of a product. In an organisation, every division such as sales and marketing, customer service, finance, and accounting and taxation has to follow certain ethics. Public image – In order to gain public confidence and respect, organisations must ascertain that they are honest in their transactions. The services or products of a business affect the lives of thousands of people. It is important for the top management to impart high ethical standards to their employees, who develop these services or products. A company that is ethically and socially responsible has a better public image. People tend to favour the products and services of such organisations. Investors’ trust is just as important as public image for any business. A company that practices good ethical creates a positive impression among its stakeholders. Management’s credibility with employees – Common goals and values are developed when employees feel that the management is ethical and genuine. Management’s credibility with employees and the public are intertwined. Employees feel proud to be a part of an organisation that is respected by the public. Generous compensations and effective business strategies do not always guarantee employee loyalty; organisation ethics is equally significant. Thus, companies benefit from being ethical because they attract and retain good and loyal employees. Better decision-making – Decisions made by an ethical management are in the best interests of the organisation, its employees, and the public. Ethical decisions take into account various social, economic and ethical factors. Profit maximisation – Companies that emphasise on ethical conduct are successful in the long run, even though they lose money in the short run. Hence, a business that is inspired by ethics is a profitable business. Costs of audit and investigation are lower in an ethical company. Protection of society – In the absence of proper enforcement, organisations are responsible to practice ethics and ensure mechanisms to prevent unlawful events. Thus, by propagating ethical values, a business organisation can save government resources and protect the society from exploitation. Most countries have similar ethical values, but are practiced differently. This section deals with the way individuals in different countries approach ethical issues, and their ethically acceptable behaviour. With the rise in global firms, issues related to ethical values and traditions become more common. These ethical issues create complications to Multi-National Companies (MNCs) while dealing with other countries for business. Hence, many companies have formulated well-designed codes of conduct to help their employees. Two of the most prominent issues that managers in MNCs operating in foreign countries face are bribery and corruption and worker compensation. 2011 Abhishek Jain - 511035358 Page 12 of 19

MBA 4th Sem Assignment

International Business Management – MB0053 – Set 1

Bribery and corruption – Bribery can be defined as the act of offering, accepting, or soliciting something of value for the purpose of influencing the action of officials in the discharge of their duties. Corruption is the abuse of public office for personal gain. The issue arises when there are differences in perception in different countries. For example, in the Middle East, it is perfectly acceptable to offer an official a gift. In Britain it is considered as an attempt to bribe the official, and hence, considered unlawful. Worker compensation – Businesses invest in production facilities abroad because of the availability of low-cost labour, which enables them to offer goods and services at a lower price than their competitors. The issue arises when workers are exploited and are underpaid compared to the workers in the parent country who are paid more for the same job. The disparity arises due to the differences in the regulatory standards in the two countries. Earlier, we believed that ethics is a prerogative of individuals, but now this perception has immensely changed. Many companies use management techniques to encourage ethical behaviour at an organisational level. Code of conduct for MNCs The code of conduct for MNCs refers to a set of rules that guides corporate behaviour. These rules prescribe the duties and limitations of a manager. The top management must communicate the code of conduct to all members of the organisation along with their commitment in enforcing the code. Some of the ethical requirements for international companies are as follows: o Respect basic human rights. o Minimise any negative impact on local economic policies. o Maintain high standards of local political involvement. o Transfer technology. o Protect the environment. o Protect the consumer. o Employ labour practices that are not exploitative. When a manager of an international firm faces an ethical problem, certain models help in solving these ethical issues Culture is a major factor which influences marketing decisions and practices in a foreign country. For example, in the middle-eastern countries the prior approval of the governing authorities should be taken if a firm plans to advertise a product related to women’s apparel, as showcasing some aspects of women clothing is considered immodest and immoral. Q.5 Discuss the international marketing strategies. How is it different from domestic marketing strategies? Ans: International marketing refers to marketing of goods and products by companies overseas or across national borderlines. The techniques used while dealing overseas is an extension of the techniques used in the home country by the company. Taking into account the various conditions on which markets vary and depend, appropriate marketing strategies should be devised and adopted. Like, some countries prevent foreign firms from entering into its market space through protective legislation. Protectionism on the long run results in inefficiency of local firms as it is inept towards competition from foreign firms and other technological advancements. It also increases the living costs and protects inefficient domestic firms. To counter this scenario firms must learn how to enter foreign markets and increase their global competitiveness. Firms that plan to do business in foreign land find the marketplace different from the domestic one. Market sizes, customer preferences, and marketing practices all vary; therefore the firms planning to venture abroad must analyse all segments of the market in which they expect to compete. The decision of a firm to compete internationally is strategic; it will have an effect on the firm, including its management and operations locally. The decision of a firm to compete in foreign markets has many reasons. Some firms go abroad as the result of potential opportunities to exploit the market and to grow globally. And for some it is a policy driven decision to globalise and to take advantage by pressurising competitors. But, the decision to compete abroad is always a strategic down to business decision rather than simply a reaction. Strategic reasons for global expansion are: o Diversifying markets that provide opportunistic global market development. 2011 Abhishek Jain - 511035358 Page 13 of 19

MBA 4th Sem Assignment

International Business Management – MB0053 – Set 1

o Following customers abroad (customer satisfaction). o Exploiting different economic growth rates. o Pursuing a global logic or imperative to harvest new markets and profits. o Pursuing geographic diversification. o Globalising for defensive reasons. o Exploiting product life cycle differences (technology). o Pursuing potential abroad. Likewise, there can be other reasons like competition at home, tax structures, comparative advantage, economic trends, demographic conditions, and the stage in the product life cycle. In order to succeed, a firm should carefully look at their geographic expansion and global marketing strategy. To a certain extent, a firm makes a decision about its extent of globalisation by taking a stance that may span from entirely domestic to a global reach where the company devotes its entire marketing strategy to global competition. In the process of developing an international marketing strategy, the firm may decide to do business in its home-country (domestic operations) only or host-country (foreign country) only. Segmentation Firms that serve global markets can be segregated into several clusters based on their similarities. Each such cluster is termed as a segment. Segmentation helps the firms to serve the markets in an improved way. Markets can be segmented into nine categories, but the most common method of segmentation is on the basis of individual characteristics, which include the behavioural, psychographic, and demographic segmentations. The basis of behavioural segmentation is the general behavioural aspects of the customers. Demographic segmentation considers the factors like age, culture, income, education and gender. Psychographic segmentation takes into account: beliefs, values, attitudes, personalities, opinions, lifestyles and so on. Market positioning The next step in the marketing process is, the firms should position their product in the global market. Product positioning is the process of creating a favourable image of the product against the competitor’s products. In global markets product positioning is categorised as high-tech or high– touch positioning. One challenge that firms face is to make a trade-off between adjusting their products to the specific demands of a country and gaining advantage of standardisation such as the maintenance of a consistent global brand image and cost savings. This is task is not easy. International product policy Some thinkers of the industry tend to draw a distinction between conventional products and services, stressing on service characteristics such as heterogeneity (variation in standards among providers, frequently even among different locations of the same firm), inseparability from consumption, intangibility, and perishability. Typically, products are composed of some service component like, documentation, a warranty, and distribution. These service components are an integral part of the product and its positioning. Firms have a choice in marketing their products across markets. Many a times, firms opt for a strategy which involves customisation, through which the firm introduces a unique product in each country, believing that tastes differ so much between countries that it is necessary to create a new product for each market. On the other hand, standardisation proposes the marketing of one global product, with the belief that the same product can be sold in different countries without significant changes. For example, Intel microprocessors are the same irrespective of the country in which they are sold. Finally, in most cases firms will go for some kind of adaptation. Here, when moving a product between markets minor modifications are made to the product. For example, in U.S. fuel is relatively cheap, therefore cars have larger engines than the cars in Asia and Europe; and then again, much of the design is identical or similar. International pricing decisions Pricing is the process of ascertaining the value for the product or service that will be offered for sale. In international markets, making pricing decisions is entangled in difficulties as it involves trade barriers, multiple currencies, additional cost considerations, and longer distribution channels. Before establishing the prices, the firm must know its target market well because when the firm is clear about the market it is serving, then it can determine the price appropriately. The pricing policy must be consistent with the firms overall objectives. Some common pricing objectives are: profit, return on investment, survival, market share, status quo, and product quality. The strategies for international pricing can be classified into the following three types: 2011 Abhishek Jain - 511035358 Page 14 of 19

MBA 4th Sem Assignment

International Business Management – MB0053 – Set 1

· Market penetration· Market holding: · Market skimming: The factors that influence pricing decisions are inflation, devaluation and revaluation, nature of product or industry and competitive behaviour, market demand, and transfer pricing. The approach taken by company towards pricing when operating in international markets are ethnocentric, polycentric, and geocentric. Price can be defined by the following equation:

The pricing decision enables us to change the price in many ways, some of them are: · “Sticker” price changes –. · Change quantity –· Change quality –· Change terms – Transfer pricing Transfer pricing is the process of setting a price that will be charged by a subsidiary (unit) of a multiunit firm to another unit for goods and services, which are sold between such related units. Transfer pricing is determined in three ways: market based pricing, transfer at cost and cost-plus pricing. The Arm’s Length pricing rule is used to establish the price to be charged to the subsidiary. Many managers consider transfer pricing as non-market based. The reason for transfer pricing may be internal or external. Internal transfer pricing include motivating managers and monitoring performance. External factors include taxes, tariffs, and other charges. Transfer Pricing Manipulation (TPM) is used to overcome these reasons. Governments usually discourage TPM since it is against transfer pricing, where transfer pricing is the act of pricing commodities or services. However, in common terminology, transfer pricing generally refers TPM. International advertising International advertising is usually associated with using the same brand name all over the world. However, a firm can use different brand names for historic reasons. The acquisition of local firms by global players has resulted in a number of local brands. A firm may find it unfavourable to change those names as these local brands have their own distinctive market. The purpose of international advertising is to reach and communicate to target audiences in more than one country. The target audience differ from country to country in terms of the response towards humour or emotional appeals, perception or interpretation of symbols and stimuli and level of literacy. Sometimes, globalised firms use the same advertising agencies and centralise the advertising decisions and budgets. In other cases, local subsidiaries handle their budget, resulting in greater use of local advertising agencies. International advertising can be thought of as a communication process that transpires in multiple cultures that vary in terms of communication styles, values, and consumption patterns. International advertising is a business activity and not just a communication process. It involves advertisers and advertising agencies that create ads and buy media in different countries. This industry is growing worldwide. International advertising is also reckoned as a major force that mirrors both social values, and propagates certain values worldwide. International promotion and distribution Distribution of goods from manufacturer to the end user is an important aspect of business. Companies have their own ways of distribution. Some companies directly perform the distribution service by contacting others whereas a few companies take help from other companies who perform the distribution services. The distribution services include:  The purchase of goods.  The assembly of an attractive assortment of goods.  Holding stocks.  Promoting sale of goods to the customer.  The physical movement of goods. In international marketing, companies usually take the advantage of other countries for the distribution of their products. The selection of distribution channel is helpful to gain the competitive advantage. The distribution channel is also dependent on the way to manage and control the channel. Selecting the distribution channel is very important for agents and distributors. Domestic vs. International marketing Domestic marketing refers to the practice of marketing within a firm’s home country. Whereas International or foreign marketing is the practice of marketing in a foreign country; the marketing is for the domestic operations of the firm in that country. Domestic marketing finds the "how" and "why" a product succeeds or fails within the firm’s home country and how the marketing activity affects the outcome. Whereas, foreign marketing deals with 2011 Abhishek Jain - 511035358 Page 15 of 19

MBA 4th Sem Assignment

International Business Management – MB0053 – Set 1

these questions and tries to find answers according to the foreign market conditions and it provides a micro view of the market at the firm’s level. In domestic marketing a firm has insight of the marketing practices, culture, customer preferences, climate and so on of its home country, while it is not totally aware of the policies and the market conditions of the foreign country. The stages that have led to achieve global marketing are:  Domestic marketing – Firms manufacture and sell products within the country. Hence, there is no international phenomenon.  Export marketing – Firms start exporting products to other countries. This is a very basic stage of global marketing. Here, the products are developed based on the company’s domestic market although the goods are exported to foreign countries.  International marketing – Now, Firms start to sell products to various countries and the approach is ‘polycentric’, that is, making different products for different countries.  Multinational marketing – In this stage, the number of countries in which the firm is doing business gets bigger than that in the earlier stage. And hence, the company identifies the regions to which the company can deliver same product instead of producing different goods for different countries. For example, a firm may decide to sell same products in India, Sri lanka and Pakistan, assuming that the people living in this region have similar choice and at the same time offering different product for American countries. This approach is termed ‘regiocentric approach’.  Global marketing – Company operating in various countries opts for a common single product in order to achieve cost efficiencies. This is achieved by analysing the requirements and the choice of the customers in those countries. This approach is called ‘Geocentric approach’. The practice of marketing at the international stage does not designate any country as domestic or foreign. The firm is not considered as the corporate citizen of the world as it has a home base. The firm must not have a ’single marketing plan’, because there are differences between the target markets (that is domestic or international markets). There should never be a rigid marketing campaign. A firm that is successful internationally first obtains success locally. Few approaches that you can consider for an international marketing are:  Advertise as a foreign product – By doing so, the product will be considered as genuine and original in some countries.  Joint partnership with a local firm – finding a firm that has already established credibility will benefit a lot. The product will be considered as a local product by following this marketing approach.  Licensing – You can sell the rights of your product to a foreign firm. Here the problem is that the firm may not maintain the quality standard and therefore may hurt the image of the brand. Culture is a major factor which influences marketing decisions and practices in a foreign country. For example, in the middle-eastern countries the prior approval of the governing authorities should be taken if a firm plans to advertise a product related to women’s apparel, as showcasing some aspects of women clothing is considered immodest and immoral. Q.6 Explain briefly the international financial management components with examples and applicability Ans: The term ‘Financial Management’ refers to the proper maintenance of all the monetary transactions of the organisation. It also means recording of transactions in a standard manner that will show the financial position and performance of the organisation. The Financial Management can be categorised into domestic and international financial management. The domestic financial management refers to managing financial services within the country. International financial management refers to managing finance and share between the countries. The main aim of international finance management is to maximise the organisation’s value that in turn will increase the impact on the wealth of the stockholders. When the doors of liberalisation opened, entrepreneurs capitalised the opportunity to step their foot to conduct business in different parts of the world. International trade gave way for the growth of international business. For a corporation to be successful, it is vital to manage the finance and business accounts appropriately. The rise in significance and complexity of financial administration in a global environment creates a great challenge for financial managers. The contributions of different financial innovations like currency derivative, international stock listing, and multicurrency bonds have necessitated the accurate

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MBA 4th Sem Assignment

International Business Management – MB0053 – Set 1

management of the flow of international funds through the study of international financial management. The International Financial Management (IFM) came to its existence when the countries all over the world started opening their doors for each other. This phenomenon is also called as liberalisation. But after the end of the Second World War, the integration in terms of foreign activities has grown substantially. The firms of all types are now opting to operate their business and deploy their resources abroad. Furthermore, the differences between the countries have persisted that has given rise to the prevalence of market imperfections Components of International Financial Management Foreign exchange market The Foreign exchange or the forex markets facilitates the participants to obtain, trade, exchange and speculate foreign currency. The foreign exchange market consists of banks, central banks, commercial companies, hedge funds, investment management firms and retail foreign exchange brokers and investors. It is considered to be the leading financial market in the world. It is vital to realise that the foreign exchange is not a single exchange, but is created from a global network of computers that connects the participants from all over the world. The foreign exchange market is immense in size and survives to serve a number of functions ranging from the funding of cross-border investment, loans, trade in goods, trade in services and currency speculation. The participant in a foreign exchange market will normally ask for a price. The trading in the foreign exchange market may take place in the following forms:  Outright cash or ready – foreign exchange currency deals that take place on the date of the deal.  Next day – foreign exchange currency deals that take place on the next working day.  Swap – Simultaneous sale and purchase of identical amounts of currency for different maturities.  “Spot” and “Forward” contracts – A Spot contract is a binding obligation to buy or sell a definite amount of foreign currency at the existing or spot market rate. A forward contract is a binding obligation to buy or sell a definite amount of foreign currency at the pre-agreed rate of exchange, on or before a certain date. The advantage of spot dealing has resulted in a simplest way to deal with all foreign currency requirements. It carries the greatest risk of exchange rate fluctuations due to lack of certainty of the rate until the deal is carried out. The spot rate that is intended to receive will be set by current market conditions, the demand and supply of currency being traded and the amount to be dealt. In general, a better spot rate can be received if the amount of dealing is high. The spot deal will come to an end in two working days after the deal is struck. A forward market needs a more complex calculation. A forward rate is based on the existing spot rate plus a premium or discounts which are determined by the interest rate connecting the two currencies that are involved. For example, the interest rates of UK are higher than that of US and therefore a modification is made to the spot rate to reflect the financial effect of this differential over the period of the forward contract. The duration will be up to two years for a forward contract. A variation in foreign exchange markets can be affected to any company whether or not they are directly involved in the international trade or not. This is often referred to as ‘Economic’ foreign exchange and most difficult to protect a business. The three ways of managing risks are as follows:  Choosing to manage risk by dealing with the spot market whenever the need of cash flow rises. This will result in a high risk and speculative strategy since one will not know the rate at which a transaction is dealt until the day and time it occurs. Managing the business becomes difficult if it depends on the selling or buying the currency in the spot market.  The decision must be made to book a foreign exchange contract with the bank whenever the foreign exchange risk is likely to occur. This will help to fix the exchange rate immediately and will give a clear idea of knowing the exact cost of foreign currency and the amount to be received at the time of settlement whenever this due occurs.  A currency option will prevent unfavourable exchange rate movements in the similar way as a forward contract does. It will permit gains if the markets move as per the expectations. For this base, a currency option is often demonstrated as a forward contract that can be left if it is not followed. Often banks provide currency options which will ensure protection and flexibility, but the likely problem to arise is the involvement of premium of particular kind. The premium involved might be a cash amount or it could also influence into the charge of the transaction. Foreign currency derivatives 2011 Abhishek Jain - 511035358 Page 17 of 19

MBA 4th Sem Assignment

International Business Management – MB0053 – Set 1

Currency derivative is defined as a financial contract in order to swap two currencies at a predestined rate. It can also be termed as the agreement where the value can be determined from the rate of exchange of two currencies at the spot. Hence, the spot market exposures can be enclosed with the currency derivatives. The main advantage from derivative hedging is the basket of currency available. Figure 1 describes the examples of currency derivatives. The derivatives can be hedged with other derivatives. In the foreign exchange market, currency derivatives like the currency features, currency options and currency swaps are usually traded. The agreement undertaken to exchange cash flow streams in one currency for cash flow streams in another currency in future is provided by currency swaps. These will help to increase the funds of foreign currency from the cheapest sources.

Figure 1: Example for Foreign Currency Derivatives Some of the risks associated with currency derivatives are:  Credit risk takes place, arising from the parties involved in a contract.  Market risk occurs due to adverse moves in the overall market.  Liquidity risks occur due to the requirement of available counterparties to take the other side of the trade.  Settlement risks similar to the credit risks occur when the parties involved in the contract fail to provide the currency at the agreed time.  Operational risks are one of the biggest risks that occur in trading derivatives due to human error.  Legal risks pertain to the counterparties of currency swaps that go into receivership while the swap is taking place. International monetary systems The international monetary systems represent the set of rules that are agreed internationally along with its conventions. It also consists of set of rules that govern international scenario, supporting institutions which will facilitate the worldwide trade, the investment across cross-borders and the reallocation of capital between the states. International monetary systems provide the mode of payment acceptable between buyers and sellers of different nationality, with addition to deferred payment. The global balance can be corrected by providing sufficient liquidity for the variations occurring in trade. Thereby it can be operated successfully. The gold and gold bullion standards The gold standard was the first modern international system. It was operating during the late 19th and early 20th centuries, the standard provided for the free circulation between nations of gold coins of standard specification. The gold happened to be the only standard of value under the system. The advantages of this system depend in its stabilising influence. Any nation which exports more than its import would receive gold in payment of the balance. This in turn has resulted in the lowered value of domestic currency. The higher prices lead to the decreased demands for exports. The sudden increase in the supply of gold may be due to the discovery of rich deposit, which in turn will result in the increase of price abruptly. This standard was substituted by the gold bullion standard during the 1920s; thereby the nations no longer minted gold coins. Instead, reversed their currencies with gold bullion and determined to buy and sell the bullion at a fixed cost. This system was also discarded in the 1930s. The gold-exchange system Trading was conducted internationally with respect to the gold-exchange standard following World War II. In this system, the value of the currency is fixed by the nations with respect to some foreign 2011 Abhishek Jain - 511035358 Page 18 of 19

MBA 4th Sem Assignment

International Business Management – MB0053 – Set 1

currency but not with respect to gold. Most of the nations fixed their currency to the US dollar funds in the United States. With a view to maintain a stable exchange rate at the global level, the International Monetary Fund (IMF) was created at the ‘Bretton Woods international Conference’ held in 1944. The drain on the US gold reserves continued up to the 1970s. Later in 1971, the gold convertibility was abandoned by the United States leaving the world without a single international monetary system. Floating exchange rates and recent development After the abundance of the gold convertibility by the US, the IMF in 1976 decided to be in agreement on the float exchange rates. The gold standard was suspended and the values of different currencies were determined in the market. The ‘Japanese yen’ and the ‘German Deutschmark’ strengthened and turned out to be increasingly important in international financial market, at the same time the US dollar diminished its significance. The Euro was set up in financial market in 1999 as a replacement for the currencies. Hence, it became the second most commonly used currency after the dollar in the international market. Many large companies opt to use euro rather than the dollar in bond trading with a goal to receive better exchange rates. Very recently the some of the members of Organisation of Petroleum Exporting Countries (OPEC) such as Saudi Arabia, Iraq have opted to trade petroleum in Euro than in Dollar. International financial markets International foreign markets provide links connecting the financial markets of each country and independent markets external to the authority of any one country. The heart of the international financial market is being governed by the market of currency where the foreign currency is denominated by the international trade and investment. Hence the purchase of goods and services is preceded by the purchase of currency. The purpose of the foreign currency markets, international money markets, international capital markets and international securities markets are as follows:  The foreign currency markets – The foreign currency market is an international market that is familiar in structure. This means that there exists no central place where the trading can take place. The ’market’ is actually the telecommunications like among financial institutions around the globe and opens for business at any time. The greater part of the worlds that deal in foreign currencies is still taking position in the cities where international financial activity is centred.  International money markets – A money market can be conventionally defined as a market for accounts, deposits or deposits that include maturities of one year or less. This is also termed as the Euro currency markets which constitute an enormous financial market that is beyond the influence and supervision of world financial and government authorities. The Euro currency market is a money market for depositing and borrowing money located outside the country where that money is officially permitted tender. Also, Euro currencies are bank deposits and loans existing outside any particular country.  International capital markets – The international capital provides links among the capital markets of individual countries. It also comprises a separate market of their own, the capital market that flows in to the Euro markets. The firms enjoy the freedom to raise capital, debit, fixed or floating interest rates and maturities varying from one month to thirty years in an international capital markets.  International security markets – The banks have experienced the greatest growth in the past decade because of the continuity in providing large portion of the international financial needs of the government and business. The private placements, bonds and equities are included in the international security market. The following are the reasons given for the enormous growth in the trading of foreign currency:  Deregulation of international capital flows – Without the major government restrictions, it is extremely simple to move the currencies and capital around the globe. The majority of the deregulation that has differentiated government policy over the past 10 to 15 years.  Gain in technology and transaction cost efficiency – The advancements in technology is not only taking place in the distribution of information, in addition to the performance of exchange or trading. This has resulted greatly to the capacity of individuals on these markets to accomplish instantaneous arbitrage.  Market upwings – The financial markets have become increasingly unstable over recent years. There are faster swings in the stock values and interest rates, adding to the enthusiasm for moving further capital at faster rates.

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