Sreejaya t b

Mcom 18

Roll.no: 27

Total pages: 7

INTERNATIONAL FINANCE
1. Investment decisions of MNCs

In general, MNCs try to achieve efficiency by minimizing their cost and maximising
economies of scale while reducing duplication. They invest in defferent locations to
get different advantages from host countries in order tooperate better in their home
base, but when we analyse in detail, different factors are noticed , which lead firm to
expand and invest abroad and become multinational.

 Looking for domestic markets to sell more goods , seeking raw materials and
managerial knowledge or technology and try to find countries where factors
of production are cheaper are the main motivation behind global expansion
of companies.
 Multinational companies are looking for the perfect mix of their factors in
answering the “where to invest” question. While labour costs and attributes
of the workforce such as skill and educational levels are critical variables of
investment decision , the purchasing cover of the market and proximity to
the other market are taken in to consideration in taking the investment
decision . additionaly , the type of investment such as joint venture or wholly
owed subsidiaries highly affects the investment decisions .
 The motivation of MNCs for investing in developing countries, which attracts
most of the investment of NCs in the 20th century , differs from that for
investing in developed countries, since the return of investments higher with
its risk premium . as an example , even though there have been
improvements in the situation , investers face problems with enforcing
intellectual property rights and those selling branded products often have to
deal with counterfeits in china, which is the main destination of MNCs
investments.
 Market size and growth prospect of the host county, the availability of
infrastructure , reasonable level of taxation and over all stability of the tax
regime , stable political environment , as well as condition that support
physical and personal security , legal framework and rule of laws etc..
constitute the main concern of MNCs in taking their decisions in developing
countries
 The openness of the host country to international trade is another dimension
that affects investment decisions of MNCs which allows the companies to
export their final product to alternative markets easily and without limiting
their sales operations with the host county market . as a result of this ,
foreign investors prefer counties that trade more with the rest of the world.
 The legal framework and rule of law concepts are of high importance in
developing countries and these factors are directly linked to the existence of
 good institutions with structural rule and regulations. While it is evident that
the existence of proper mechanism does not directly affect investment
decision of companies, they have positive influence on the development
through the promotion of investment in general, which face less uncertainty
and higher expected rates of return.
 Additionally, good governance which includes securing property rights
establishing efficient public sector , minimising “ dead weight” regulations,
restriction on trade and particularly securing transparency in government as
defined as factors which promote successful economic performance ,
encourage FDI by increasing the scope for profitable business activities.

3) MNCs

An MNCs can be defined as a company with production and distribution facilities in more
than one country.

Advantages

 Restructuring of the economy

MN corporations help in reorganising of the economic infrastructure in the host
country.
 As a source of capital for achieving higher rate of national growth
Important contribution of MNCs is its role is supplying additional capital investment
for filing the resource gap between targeted investment and domestically mobilised
saving s. Eg: if India wanted to achieve a 9% growth rate , we would have made a
saving of 12% , but the actual domestic saving is only about 16, which falls by 5% of
the desired figure. This can possibly be covered by bringing in FDI s from MNCs for
achieving its targeted rate of growth.
 Correction of trade deficit
An inflow of foreign capital can reduce or even remove the deficit in the balance of
payments if the capital brought by MNCs can generate a net positive flow of export
earings.
 More revenue for the country:
Profits earned by the MNCs can be taxed and thereby it is revenue for the country
which the nation could use for funding developmental projects.
 Acts as a resource package
MN not only provide resources but they also supply a “package” of needed resources
including managerial expertise, entrepreneurial abilities, and technological skills.
 These can be transferred to their local counterparts by means of training programs
and the process of learning by doing.
 Transfer of technology
MNCs bring with their most sophisticated technological knowledge about production
process while transferring modern machinery and equipment to capital poor
countries . such transfers of knowledge , skills, and technology are assumed to be
both desirable and productive for the recipient country.

Disadvantage

 Competition of domestic players

Even though MNCs do bring in capital, they give a stiff competition to the domestic
playes of the host country. At least in some cases they will ask for exclusive
production agreements with the host governments. MNCs often take their profits
back into their home country

 Indigenous entrepreneurship : MNCs inhibit the growth of indigenous

entrepreneurship with their dominance in local market
 Culture of consumerism

MNCs create a pattern of consumption among the people, which results in increased
spending and reduced savings

 Undue influence

MNCs often influences governments to make policies in ways favourable to them which is
against the social cause of the existence of government its self.

 Exploitation of natural resources

Unethical exploitation of natural resources occur because of the quest for profit of MNCs
and to gain competitive advantage in international markets.

4) absolute ppp

Absolute PPP is a static concept which states that the ratio of price level of two nations
constitutes their exchange rate . this concept is based on law of one price, ie the price of the
same product in different countries should be equal otherwise arbitrage will correct the
disparities.

The absolute PPP indicates :

$ = Pus

£ Puk

Relative PPP

Relative PPP is a concept which state that the inflation rate of individual nations have
effects on the purchasing power of those countries . relative PPP is related to macro
economic variables namely , inflation and currency value . according to this theory , if one
country has an inflation rate higher than that of another country , the country with the
higher rates currency should depreciate to the level of the other currency.this concept
states that these is an inverse relationship between rate of inflation and currency value .
when the rate of inflation increases the currency depreciates and vice versa.

Difference between relative PPP and ABSOLUTE ppp

Economists use two version of PPP: absolute PPP and relative PPP . Absolute ppp is based
on the law of one price ie, if two or more countries produce identical product , the price of
the product should be same no matter which country produce it . it only states the
estimation of expected exchange rate . relative ppp state that there is an inve4rse
relationship between national price level and currency value . relative ppp not only
estimates the expected exchange rate but also explains the behaviour of exchange rate .

The absolute ppp indicates that the exchange rate has to reflect the ratio of two countries
price level. However this is not easy. In reality\; there are market imperfection such as non
transferable inputs, transportation costs, tariff, quotas, and so forth. Therefore, the relative
ppp takes these market imperfection rate and the price level of two countries.

5) foreign exchange risk

 Foreign exchange risk is a financial risk that exists when a financial transaction is
denominated in a currency other than that of the base currency of the company. Foreign
exchange risk also exists when the foreign subsidiary of a firm maintains financial
statement in a currency other than the reporting currency of the consolidated entity.
The risk is that there may be an adverse movement in the exchange rate of the
denomination currency in relation to the base currency before the date the transaction
is completed foreign exchange risk or foreign exchange exposure magnitude depents on
the value of the changes in the foreign exchange rates which is turn depends on various
variables such as the interest rate parity , PPP, speculation and government policies on
exchange rates. A company or businesses is said to be at foreign exchange risk if the
changes in the foreign exchange rates affect its performance positively or negatively.
These exposures may be classified in to 3 category:

 Translation exposure
 Transaction exposure
 Economic exposure

Techniques in managing the foreign exchange risk

 Dealing with translation risk

In the case of translation exposure, the MNCs try to equalise the amount of exposed
foreign currency asset and liabilities. By doing so the company will be able to offset
any gain or loss it may have due to changes in the exchange rate of that currency .
this method of covering the risk is knows as balance sheet hedging in india, the
consolidation of account of the foreign subsidiaries is not a mandatory requirements
for the parent company and therefore the translation exposure is not relevant in
present scenario.

 Dealing with economic risk

In the case of economic risk, MNCs diversify either its finance or its operations. Operations
of an MNCs can be diversified by:

Changing of location where the cost of production is low

Adoption a flexible supplier policy
Changing the target market for its products
Changing the types of products it deals in

 Dealing with transaction risk

The covering of transaction risk can be done by either hedging strategies or by making
policy changes . the commonly used policy changes for covering of transaction risk are:

Matching currency cash flow

Risk sharing agreement

Back to back loans

Lead and lag payments

Use of re invoicing centers

2) arbitrage is the entire process of buying assets in one market and selling them in another
to derive huge profits from the price difference in these markets. This violates the
expectation that the same product should sell fore the same price. Arbitrage offers
guaranteed profits with no risk, and therefore undermines the stability and functionality of
the markets . the concept of arbitrage is of particular importance in international finance
because so many of the relation between domestic and international financial market ,
interest rate, and inflation rates depend on arbitrage existence.

The law of one price concludes that identical goods must have identical price. That is in an
efficient market price of identical goods will be equal . a more approximate form of this low
states that if very similar goods have vastly differing prices, their prices will converge
towards the same price .