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INTERNATIONAL
FINANCIAL
MANAGEMENT

1

Theories of determining foreign exchange rate – International Parity condition.INTERNATIONAL FINANCIAL MANAGEMENT UNIT – 1: International Financial System: Meaning. Indian Foreign Currency Market – Foreign Exchange Management Act (FEMA) – Recent development (Problems and cases). and economic exposure. GDRs. ADRs. Finance function in global context – International Monetary System – fixed and floating systems – Balance of Payments (BOP). and interest rate futures. Transaction. Techniques and Hedging strategies for foreign exchange risk management UNIT – IV: International Monetary System: Forwards. Asian Currency Markets. International Financial Institutions – World Bank – IMF – ADB UNIT – II: Foreign Exchange Market: Players and components.[Type text] SYLLABUS 333. Swaps. International Financial System – Components and environment. scope and significance of International Finance. functions – Foreign Exchange Rates – Spot – Forward and Cross Rates. UNIT – III: Management of Foreign Exchange Risk: Meaning and types of risk – Management of Translation. Blocked Accounts. Speculation and leveraged arbitrage UNIT – V: Financial Management of Multinational Firm – Foreign Capital Budgeting Decisions – Cash Flow Management – Tax and Accounting implications of International activities 2 . Tools. European Monetary markets. Dealing position.

Financial dealings outside of nation’s boundaries. ii. The exchange of one currency for another. Market Participants iii. ii. Difference between International and Domestic financial system: The international financial system differs from domestic financial system in the following aspects: i. Financial Markets ii. Borrowing and lending of money across borders. iii. Trading in foreign currencies and foreign assets or liabilities and claims. The exchange of goods and services involving payments and receipts as between countries. 6) Supply and demand is limited to home country 3 . Transactions in foreign currencies. International Financial Management Domestic Financial Management 1) Investments are made internationally 1) Investments are retained in the 2) Desire for high expansion and are more domestic (home) country only ambitious 2) Less ambitious so less expansion 3) Competition is more as it goes globally 3) Competition is less 4) High risk is faced in the global market 4) Less Risk 5) Large investments are made in 5) Less investments are made for research Research and development and development 6) Supply and Demand goes global.[Type text] UNIT I INTERNATIONAL FINANCIAL SYSTEM INTRODUCTION: The domestic financial system consists of 4 basic elements. Financial Claims iv. They are given as i. Market facilitators or regulators Where as the international financial system consists of the following elements: i. iv.

[Type text] Meaning of International Financial System: International Financial System deals with the financial decisions taken in the area of international business. Thus the study of financial management has become significant and it covers:  Foreign exchange markets  MNC’s financial Investments  Financial investment decisions of MNC (Multinational Company)  International accounting and taxation  International working capital Decisions SCOPE AND SIGNIFICANCE OF INTERNATIONAL FINANCIAL MANGEMENT: SCOPE: International financial management is concern with the financial aspects of international business. commercial and financial relations in between countries. SIGNIFICANCE: The international financial management benefits and significant in following ways:  It helps in taking correct financial decisions so that the maximum can be derived from international business in any mode of situation. International financial management has a wider scope than domestic corporate finance and it is designed to cope with greater range of complexities with the acceptance of the policy of economic liberalization and globalization and this led to the fast expansion in international trade in the activities of MNC’s and in international financial market. International trade aid and financial flows account for bulk of such transactions in between nations. Thus international financial management as occupied an important row of the Indian economy with Foreign Investment Institutions (FIIs) and Foreign Direct Investment (FDIs) playing a key role in the stock end capital market. it is important to have qualified and trained personnel. this is one reason to gain importance in the area of international financial dealings. 4 . International financial management can be traced to the sectored and national interdependence which leads to international economic. To handle international transactions effectively.

inflation rate. 5 . land etc  Natural Environment: Example: Natural resources. Foreign currency market: In this market the currencies are borrowed and lent. International Financial Market: This market is sub classified into: a) Foreign equity market: In this market the equities are traded globally for raising of money in the foreign market. Derivatives market: This market is classified into Futures and Options 5. Foreign Exchange Market: In this the exchange of goods and services are done for currencies. population.[Type text]  International events affect the firms and what steps to grab opportunities from positive developments and insulate from harmful ones. boom conditions in trading. social habits and customs.marketing. interest rate etc  Political and government policies: Example: Monitory policies. 4. wages. belief of culture etc  Demographic factors: Example: Size of the country. interest rates. age. 3.  Recognize how the firm will be affected by movement in exchange rate. weather & climate conditions and infrastructural factors  Technological Environment: Example: E. mobile phones etc COMPONENTS OF INTERNATIONAL FINANCIAL MANAGEMENT: The major components of international financial system are as follows: 1. internet facilities. INTERNATIONAL FINANCIAL SYSTEM ENVIRONMENT: Global environment factors effecting the international financial environment  Economic and financial factors: Example: Recession. Swap market: Swap is an agreement for exchange of forward dollars for spot dollars and vice versa or floating instruments for a fixed cost instrument. fiscal policies and political stability etc  Social and cultural factors: Example: Spirit of swadeshi. 2. inflation rate.

investment financing. 6. Controller Treasurer Financial Planning Cash Management Fund Requisition Investment Decision Investment Decisions Risk Management External Reporting Tax Planning & Management Management Information System Financial Management and accounting Budget Planning and Controlling Accounts Receivable The finance function of an international firm has two functions namely. and accounts receivables etc. The treasurer is responsible for financial planning analysis. FINANCE FUNCTIONS IN GLOBAL CONTEXT: Finance function is the part of financial management. management information system. financial and management accounting. 6 . The finance function is expected to assist the top management in formulation of strategic goal and achieve goals. funding options and investment vehicles are available for both reactive and proactive management of corporate finance. tax planning and management. On the other hand. treasury and control. For maximizing the returns from investment and to minimize the cost of finance. Since the firm has to raise funds from different financial markets of the world. controller deals with the functions related to external reporting. cash management. the firm has to take portfolio decision based on analytical skills required for this purpose. which needs to actively exploit market imperfections and the firm’s superior forecasting ability to generate purely financial gains. b) Euro bond market: The amount raised in the form of Euro bonds. investment decision and risk management. fund acquisition. c) Asian currency market: Asian dollars are borrowed and lent. International Money Market: This is further classified into: a) Euro currency market: In this the European currencies are borrowed and lent. The complex nature of managing international finance is due to the fact that a wide variety of financial instruments.[Type text] b) Foreign bond market: In this the amount is raised in the form of bonds in foreign market. budget planning and control. products.

The exchange rate between pair of two currencies was determined by respective exchange rates against 'Gold' which was called 'Mint Parity'.IMF and the WB. In Bretton Woods modified form of Gold Exchange Standard was set up with the following characteristics:  One US dollar conversion rate was fixed by the USA as one dollar = 35 ounce of Gold 7 . 1914-1944: WWI ended the classical gold standard as major countries suspended redemption of banknotes in gold and imposed ban on gold exports. rules. 1945-1973: After the war the world economy & monetary system. The international monitory system plays a crucial role in the financial management of multinational business and economic and financial policies of each country. INTERNATIONAL MONETARY SYSTEM International monetary system is defined as a set of laws. 1876-1913: The oldest system of exchange rate was known as "Gold Species Standard" in which actual currency contained a fixed content of gold. To understand the complex procedure of international trading practices. institutions to establish that rate at which exchange rate is determined in respect to other currency. The U. 3) The Bretton Woods System. which gave birth to two super institutions . The other version called "Gold Bullion Standard". the paper currency issued by them into paper currency of another country which is operating in Gold. procedures. while an understanding of economic theories and principles is necessary to estimate and model financial decisions.S has replaced Britain as the dominant financial power. Evolution of this can be analyzed in 4 stages: 1) The Gold Standard. at a fixed rate. allied powers held a conference in 'Bretton Woods'. mechanisms. have a look at the history of the financial and monetary system. where the basis of money remained fixed gold but the authorities were ready to convert.[Type text] International finance is multidisciplinary in nature. processes. financial accounting and management accounting help in decision making in financial management at multinational level. agreements. The major countries gave priority to stabilization of domestic economies by matching inflows and outflows of gold with reductions and increase in domestic money and credit. 2) The inter war years.

(v) Fixed exchange rates are more conducive to expansion of world trade because it prevents risk and uncertainty in transactions. If speculators believe that exchange rate cannot be held for long. FIXED AND FLOATING SYSTEM: (a) Fixed Exchange Rate System: A fixed exchange rate denotes a nominal exchange rate that is set firmly by the monetary authority with respect to a foreign currency or a basket of foreign currencies. (ii) It contributes to the coordination of macro policies of countries in an interdependent world economy. (iv) It prevents capital outflow. government is compelled to devalue domestic currency. (iii) Fixed exchange rate ensures that major economic disturbances in the member countries do not occur. Demerits: (i) Fear of devaluation. major industrial countries agreed to cooperate to achieve greater exchange rate stability. But when reserves are exhausted and excess demand still persists. In this system.[Type text]  Other members agreed to fix the parities of their currencies vis-à-vis dollar with respect to permissible central parity with one per cent (± 1%) fluctuation on either side. central bank uses its reserves to maintain foreign exchange rate. It is a system based purely on demand and supply for a currency in foreign exchange market. they buy foreign exchange in massive amount causing deficit in balance of payment. foreign central banks stand ready to buy and sell their currencies at a fixed price. This may lead to larger devaluation. Fixed exchange rate is the rate which is officially fixed by the government or monetary authority and not determined by market forces. In a situation of excess demand. (vi) It prevents speculation in foreign exchange market. In case of crossing the limits. This is the main flaw or demerit of fixed 8 . Merits: (i) It ensures stability in exchange rate which encourages foreign trade. Following a spectacular rise and fall of the US dollar in the 1980s. the authorities were free hand to intervene to bring back the exchange rate within limits. 4) Flexible Exchange Rate Regime since 1973: The flexible exchange rate regime that replaced the Bretton Woods system was ratified by the Jamaica Agreement.

There is no official intervention in foreign exchange market. allows the exchange rate to adjust so as to equate the supply and demand for foreign currency. (ii) There is no need for government to hold any foreign exchange reserve. flexible exchange rate is the rate which.[Type text] exchange rate system. Distinction between Fixed Exchange Rate and Flexible Exchange Rate: Fixed exchange rate is the rate which is officially fixed in terms of gold or any other currency by the government. (iv) It frees the government from problem of BOP Demerits: (i) It encourages speculation leading to fluctuations in foreign exchange rate. (ii) Wide fluctuation in exchange rate hampers foreign trade and capital movement between countries. A currency that uses a floating exchange rate is known as a floating currency. (iii) It helps in optimum resource allocation. is determined by forces of demand and supply in the foreign exchange market. Under this system. When market forces determine the rate. As against it. b) Flexible (Floating) Exchange Rate System: A floating exchange rate or fluctuating exchange rate is a type of exchange-rate regime in which a currency's value is allowed to fluctuate according to the foreign-exchange market. the central bank. without intervention. (ii) Benefits of free markets are deprived. like price of a commodity. It changes according to change in demand and supply of foreign currency. 9 . It does not change with change in demand and supply of foreign currency. The system of exchange rate in which rate of exchange is determined by forces of demand and supply of foreign exchange market is called Flexible Exchange Rate System. (iii) There is always possibility of under-valuation or over-valuation. (iii) It generates inflationary pressure when prices of imports go up due to depreciation of currency. There is no government intervention. it is called floating exchange rate Merits: (i) Deficit or surplus in BOP is automatically corrected.