International Finance

- Nikhilesh N w ni
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 • International Finance is concerned with the management of nances.
• Commonly stated goal of a rm is to maximise its value and thereby maximise shareholders
wealth.
• Goal is applicable not only to the rms that focus on domestic business, but also to rms
that focuses on international business.
• Example coca cola co. that distributes its product in more than 160 countries and uses 40
di erent currencies. Over 60 % of its total annual operating income is generated outside
the United States.
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 International Financial Mgt. is important even to companies that have no Intentional Business income
because these companies must recognise how their foreign competitors will be a ected by movements

- Exchange Rates
- Foreign Interest Rates
- Labour Costs
- In ation.

These economic characteristics can a ect the foreign competitor’s cats of production and pricing
policies
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Features of International Financial Management

Foreign Exchange Risks

Political Risks

Expanded Opportunity Sets

Market Imperfections

Foreign Exchange Risks

An understanding of foreign exchange risks is essential for managers and investors in the modern day environment of
unforeseen changes in foreign exchange rates.

When di erent national currencies are exchanged for each other, there is a de nite risk of volatility in foreign exchange rates.

Political Risk

Political risk ranges from the risk of loss (or gain) from unforeseen government actions or other events of a political character
such as - act of terrorism. MNC must assess the political risk not only in countries where it is currently doing business but also
where it expects to establish subsidiaries.
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 Expanded Opportunity Sets

When Firms go global, they also tend to bene t from expanded opportunities which are available now. They can raise
funds in capital market, where cost of capital is the lowest.

Market Imperfections

The nal feature that distinguishes it from domestic nance is that world markets today are highly imperfect. There
are profound di erences among nations laws, tax systems, business practices and general cultural environments.

Imperfections in the world nancial markets tend to restrict the extent to which investors can diversify their portfolio.
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Functions of International Financial Management

Investment Decisions

International Working Capital Decisions

Financial Decisions

International Accounting and Taxation Decisions

 Investment Decisions

When a company innovate a speci c technology and its product is mature in the markets abroad, or when the company
wants to reap the location advantage in a foreign country, it sets up an a liate there.

The company evaluates the cash in ow and out ow during the life of the project and makes investment only when the
net present value of cash ows is positive.

Studies the di erent theories of overseas production, the various strategies of investment, Capital budgeting decision
and evaluation of foreign exchange and political risks pertaining to overseas investment.

International working capital decisions

When foreign operation begins, the parent company evaluates di erent sources of working capital so that the cost of
nancing is the cheapest.

When targeting sources of funds, it has also to decide the size of current assets because these facts have a close link
with the cost of production and the overall pro tability of the rm.

I FM helps in taking a correct decision regarding the size of working capital and suggest a mechanism for its management.
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Financial decisions

Any investment needs raising of funds. The MNC's take advantage of the many innovations which have
taken place in the international nancial market and guide them on how to take advantage of these.

It deals with, how di erent instruments are issued to raise funds and how to use for minimising the cost
of funds.

International Accounting and Taxation Decisions

International accounting forms an integral part of I FM.

It analyses the techniques for consolidation of nancial statements of the various a liates, International
audit, International nance reporting and international taxation.

Similarly, International tax system should be designed that it fosters economic e ciency and does not
come in the way of the cross-border movement of goods and factors of production

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Scope of international nancial management

International nancial management is subject to several external factors, the more important of them
namely foreign exchange markets, currency convertibility, International monetary system, balance of
payments, and international nancial system

International monetary system

Balance of payments

International nancial system

Foreign exchange market

Currency convertibility
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International Monetary System

Every country needs to have its own monetary system and an authority to maintain order in the system.

Monetary system facilitates trade and investment. India has its own monitory policy that is administered by the
reserve bank of India.

RBI aims at controlling in ation and money supply and maintaining an interest rate regime that is helpful to
economic growth

Balance of payments

Balance of payments is the statistical statement that systematically summarises or for a speci ed period of time
, the monetary transactions of an economy with the rest of the world.

It helps measures nancial transactions between residents of the country and residents of all the countries.

Transactions includes exports and imports of goods and services, income ows, capital ows and gi s and
similar one-sided transfer payments.
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International Financial System

IFS consists of the numerous rules, customs, instruments, facilities, markets and organisations that enable
international payments to be made and funds to ow across borders.

International Financial Markets is driven by technological changes, the growth in the world, and the breakdown of
barriers to nancial ows.

Foreign Exchange Market:

It is the place where money denominated in one currency is bought and sold with money denominated in other
countries.

Currency Convertibility:

A countries currency is said to be freely convertible when the country’s government allows both residents and non-
residents to purchase unlimited amounts of foreign currencies with the local currency.

A currency is non convertible when neither residents nor non residents are allowed to convert local currency into a
foreign currency.

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 Exchange Rate

The rates between two countries at which they are sold or exchanged each other are known as
exchange rates’. These rates are also known as Forex Rates por Foreign Exchange rates.
Foreign Exchange rates can be understood as the transactions which takes place in the foreign
exchange market.

If 1 US dollar is transacted for 76.28 INR then the foreign exchange rate will be 1 $ = INR 76.28
which implies value of 76.28 INR is equal to 1 USD

Factors In uencing Foreign Exchange Rates

-Relative In ation Rates

-Income Levels
-Relative Quality
-Relative Interest Rates
-Levels of Foreign Direct Investments
-Government Controls
-Expectations
-International Trade
-Capital Movements
-Change in Prices
-Speculations
-Strength of the Economy
-Stock Exchange Operations
-Political Factors
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 Factors In uencing Foreign Exchange Rates

-Relative In ation Rates

A Country dealing with high in ation rate may face falling demand for Export and rising
demand for Imports. Thus, leads to decrease in demand of currency of that country, while the
supply of currency will Increase, results in decrease in exchange rates for the currency.

-Income Levels

The Exchange rate of currency will increase, if Income level of the country is rising. This is
possible because the foreigners have high purchasing power to spend money on the exports of
the country. On Contrary to this, the exchange rate of a currency will decrease, if Income level
of the domestic country is rising.
Thus in such case, the rms are forced to sell their products in domestic country, rather
o ering to the export markets.
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-Relative Quality

When the products producing in a country are of higher quality, then the demand for such
products shall be greater in both markets.
Increase demand will li up the oating exchange rate and impose pressure on xed exchange
rate to move upward. Same, if activities of marketing and a er sale services are improving.

-Relative Interest Rates

When Interest rates prevailing in a country are higher, then the foreign investors are
encouraged to make investment in that country, intern increase the in ow of fund from the
other countries, thus the demand of the currency will increase and impose pressure on xed
exchange rate to move upward.

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-Levels of FDI

A country can increase value of its currency and can impose pressure on xed exchange rate to
move upward, if it encourages foreign MNC’s to make investment in its own country and
discourages its domestic MNC’s to invest in other countries.

-Government Controls

An important determinant in uencing the exchange rate is involvement and control of

government in the foreign exchange market. The foreign government can e ect the exchange
rate in the following manner:

a) It can impose obstructions on foreign exchange,

b) It can impose obstructions on foreign trade,
c) It can actively involve in trading of currencies in the currency market, and
d) It can in uence the macroeconomic variables like in ation, interest rates and Income
levels.
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 -Expectations

Exchange rates may get a ected because of market expectations about the exchange rates.
similar to the nancial market, Foreign exchange market is also making response to a fresh
announcement that may in uence the market in future.
Ex: Us in ation in uenced the currency traders to sell the dollars, as they expect that value of
dollar will decrease in future, and imposed pressure on US exchange rate to move downward.

-International Trade

Demand and Supply is based on the buying and selling of goods and services among the
di erent countries. Currency is weak or strong is completely based on the trading activities
with the other countries.
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-Capital Movements:

Value of currency of a country will increase, if it encourages the foreign investors to make
investment on easy terms or if large capital is generated from the foreign investments.
As the demand for the currency will increase on the other hand, the value of currency will
decrease, if it discourages the foreign investments or if larger volume of capital is transferred to
the other country.

-Change in Prices

Exchange rate is also in uencing from the in ation or de ation rates in an economy. As the
impact of changes in price is directly a ecting the demand and supply of home currency. Ex:
the demand for Indian Commodities shall be reduce, if the price of such commodities will rise.

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- Speculations

The Financial Market is highly unpredictable, where the money invested is subject to di erent
risks and entitled for certain degree of returns. Market is a better place for speculators to
generate maximum pro ts.
On selling a currency will increase its supply in the market and its value will decrease. While at
the same time, the demand for other currency will increase and its value will also increase.

-Strength of the Economy

The value of a country will remain constant, if that country is strong in its economic principles.
The power of an economy can be estimated from the known indicators like the scal balance,
International current account balance, International liabilities, foreign exchange reserves,
resilience to International trade uctuations, GDP, In ation rate etc. If an economy of a
country is strong then its currency is also strong.

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 - Stock Exchange Operations

The demand and supply for foreign currencies is also a ecting from the operations of stock
exchange present in the entire world, in respect of the foreign securities, debentures, stock and
shares.

-Political Factors

The Political conditions in a country are e ectively represents the strength and the weakness of
a country. As an e cient political environment in a country is suitable for the development of
that country, for gaining the trust of foreign investors and for improving the reputation of that
country in the international market.

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Factors A ecting Demand and Supply for Foreign Exchange Rate in India

Demand :

Importers
Indian Tourists
Indian Investors
Withdrawal by Foreign Investors

Supply:

Exporters
Foreign Tourist
Foreign Investors

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 Purchasing Power Parity

Purchasing power parity is the measurement of prices in di erent countries that uses the prices of
speci c goods to compare the absolute purchasing power of the countries' currencies. 

It is the Law of one good, one Price. PPP is based on the law of one price for the same product in
di erent countries.

PPP, from the point of view of IF, refers to the similarity that should exist between the prices of the same
product or basket of products in di erent countries when measured in terms of common currency.

This theory ignores the transaction costs and assumes that the products move freely without incurring
any cost. It is the only price of the product that is to be paid by the buyer.
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 Purchasing Power Parity

It is an exchange rate system under which exchange rates of various currencies are determined on
the basis of their relative Purchasing powers in their respected countries.

Example:

Exchange Rate : USA = 1 bottle of Coke for 2 L = $ 2.27

India = 1 bottle of Coke for 2 L = $ 2.27 X 76 = INR 172.52 ?

Purchase Rate in India = INR 90

In $ = ??

 Examples:

Between India and US.

Suppose an American visits a particular market in India. The Visitor bought 25 cupcakes for Rs. 250.
Visitor claimed that on average, 25 such cupcakes cost $6 in US . Calculate the Purchasing Power Parity
between India and US.

25 Cupcakes = Rs. 250

25 Cupcakes = $ 6

PPP = Cost of Good X in currency 1 / Cost of Good X in currency 2

PPP Rate = 250 /6 = 41.666667

$ 1 = RS 41.67

 Examples:

Between China and US.

Suppose McDonald’s Big Mac Cost $ 5.28 in the US. While the same can be bought at $ 3.17 in
China during the same period. ( Exchange Rate $1 = CNY 6.76 )

Calculate the Purchasing Power Parity between China and US.

 Examples:

1 Big Mac in US = $ 5.28

1 Big Mac in China = $ 3.17

IN CNY = 3.17 X 6.76 = 21.4292 or 21.43

PPP Rate = Cost of Good X in currency 1 / Cost of Good X in currency 2

PPP Rate = 21.43 / 5.28 = 4.058

$ 1 = CNY 4.058

 Examples:

1 USD= 10 Mexican pesos.

Price of 1 wooden baseball bat in US = $ 40 and Mexico = 150 Pesos.

in terms of dollars in Mexico Price of 1 bat = 150/10 = $ 15

Buyers will buy from Mexico rather than from US as bats are available at cheaper cost in Maxico.

1) Buyer will convert Dollars to Pesos to purchase it at cheaper cost. Resulting appreciation in the value of Mexican
Pesos.

2) Fall in the demand for the bats in US and will tend to reduce the prices of the bats in US

3) Rise in the demands for the bats in Mexico and will be resulting in increase in the price of the bats in Mexico.

Above three factors will tend to change the exchange rate and the price of the product in two countries to the PPP
thus making the price same in both the countries.

considering the previous situation and 3 outcomes.

1 USD= 8 Mexican pesos.

Price of 1 wooden baseball bat in US = $ 30 and Mexico = 240 Pesos.

Buyer can either purchase it from US or can convert $ 30 to 240 pesos and can come to Mexico and
buy it., thus having no bene t to prefer buying from Mexico.

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 Foreign Exchange Transactions

Transactions that involve the currency as a product, i.e, exchange of one currency for another
between the two parties.
The time and rate of exchange is pre-decided.

Helps:

- To manage currency risk concerned with export and import involving foreign currency.
- To invest or borrow from outside the country.
- To convert the dividends of foreign currencies.
- To settle other contractual arrangements of foreign currency.

Types of Transactions:

- Spot Transactions
- Forward Transactions
- Future Transactions
- Options Transactions
- Swaps Transactions

- Spot Transactions

The spot transaction is when the buyer and seller of di erent currencies settle their payments
within the two days of the deal.

It is the fastest way to exchange the currencies. Here, the currencies are exchanged over a two-
day period, which means no contract is signed between the countries.

The exchange rate at which the currencies are exchanged is called the Spot Exchange Rate. 

This rate is o en the prevailing exchange rate. The market in which the spot sale and purchase of
currencies is facilitated is called as a Spot Market.
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- Spot Transactions

The Segment of the market that involves the settling of sale and purchase of the deal is termed as ‘spot
market’.

Spot market deals with the spot sale and purchase of the foreign exchange.

Types of Spot Market:

1) Organised Market: A market where the tradable securities, commodities and foreign exchange are traded.

2) Over-the-Counter: When the trading of nancial instruments such as stocks, bonds, commodities done
directly between the two parties.
also known as O -exchange trading.

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- Spot Transactions

Someone in Europe would like to purchase a home in the US, and will need to fund their USD
account for the transaction. They will need the funds in two days, so they book a spot transaction
today, thereby locking in the rates at which the two currencies will be exchanged.

In two days’ time, they transfer the required EUR funds to the counterparty and receive the USD
into their account

- Forward Transactions

The Segment of the market that involves the sale and purchase of foreign currency at some future
date, usually a er 3 months of the deal is termed as forward market and such agreement to trade is
termed as forward market transactions.

It deals with the forward sale and purchase of foreign exchange.

Types of Foreign Exchange Contracts:

The Forward Contracts ( Regulation ) Act, 1952 is responsible for regulating the forward contracts
in India. The Act determines the following categories as the types of foreign exchange market:
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 - Forward Transactions

A forward transaction is a future transaction where the buyer and seller enter into an agreement
of sale and purchase of currency a er 90 days of the deal at a xed exchange rate on a de nite
date in the future.

The rate at which the currency is exchanged is called a Forward Exchange Rate.

The market in which the deals for the sale and purchase of currency at some future date is made
is called a Forward Market.

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 A leading beverage company enters into a contract with a co ee estate for exporting 10,000 kg
co ee beans three months from now. The current price of co ee beans is INR 500/Kg.

However, the estate is concerned about the declining co ee prices and wants to ensure that they
make sizeable pro ts from the deal.

Hence, the estate enters into a forward contract with the beverage company to sell the 10,000
kg co ee beans a er three months at a rate of INR 480 per kg, irrespective of the market price at
that point.

A er three months, the beverage company will procure the same amount of co ee beans from
the estate at an agreed price as per the forward contract.
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There are three possibilities:

- If the current market price is less than the contract price, the beverage company makes a
potential loss, in that had it not entered into a forward contract, it could have procured the
same amount at the market price. In this case, the estate saves itself from the eroding costs,

- If the market price is greater than the contract price, it’s the estate that makes a potential
loss since they could have sold the beans at an increased rate had they not entered into the
hedge contract.

- The market price is the same as the contract price. In that case, there is zero potential pro t
or loss to both parties.

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- Future Transactions

The future transactions are also the forward transactions and deals with the contracts in the
same manner as that of normal forward transactions.

- The forward contracts can be customized on the client’s request, while the future contracts
are standardized such as the features, date, and the size of the contracts is standardized.

- The future contracts can only be traded on the organized exchanges, while the forward
contracts can be traded anywhere depending on the client’s convenience.

 Forward Contract Future Contract

A futures contract is a standardized

A forward contract is an agreement between
contract, traded on a futures exchange, to
two parties to buy or sell an asset (which can
De inition buy or sell a certain underlying instrument
be of any kind) at a pre-agreed future point in
at a certain date in the future, at a
time at a speci ied price.
speci ied price.

Customized to customer needs. Usually no

Standardized. Initial margin payment
Structure & Purpose initial payment required. Usually used for
required. Usually used for speculation.
hedging.

Transaction method Negotiated directly by the buyer and seller Quoted and traded on the Exchange

Government regulated market (the

Market regulation Not regulated Commodity Futures Trading Commission
or CFTC is the governing body)
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 Forward Contract
Institutional guarantee The contracting parties
No guarantee of settlement until the date of
maturity only the forward price, based on
Guarantees
the spot price of the underlying asset is
paid
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Future Contract
Clearing House
Both parties must deposit an initial guarantee
(margin). The value of the operation is
marked to market rates with daily settlement
of pro its and losses.
 DIFFERENCE IN STOCK MARKET AND FOREX MARKET

BASIS STOCK MARKET FOREX MARKET

COMMODITY OF TRADE SECURITIES ( SHARES, DEBENTURES ) CURRENCIES

MOST STOCK MARKET OPERATES FOR 8 NO DOWNTIME IN FOREX TRADING. FOREX

TRADING HOURS
HOURS MARKET OPERATES 24 HOURS A DAY.

NOT GEOGRAPHICALLY TIED DOWN. IT IS AN

TRADING MARKET PLACE STOCK MARKET ARE CENTRALIZED
OVER THE COUNTER MARKET.

SMALLER AS COMPARED TO FOREX LARGEST MARKET OF THE WORLD IN

SIZE OF THE MARKET
MARKET. COMPARISON TO OTHER MARKET.
 - Swap Transactions

The Swap Transactions involve a simultaneous borrowing and lending of two di erent
currencies between two investors.

Here one investor borrows the currency and lends another currency to the second investor.

The obligation to repay the currencies is used as collateral, and the amount is repaid at
a forward rate. 

The swap contracts allow the investors to utilize the funds in the currency held by him/her to pay
o the obligations denominated in a di erent currency without su ering a foreign exchange risk.
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 - Swap Transactions

A currency Swap is a transaction in which two parties exchange an equivalent amount of money with each
other but in di erent currencies. The parties are essentially loaning each other money and will repay the
amounts at a speci ed date and exchange rate. The purpose could be to hedge exposures to exchange-rate
risk, to speculate on the direction of a currency, or to reduce the cost of borrowing in a foreign currency.

Two parties exchange equivalent amounts of two di erent currencies and trade back at a later speci ed
date.

How a Currency Swap Works

In a currency swap, or FX swap, the counter-parties exchange given amounts in the two currencies. For
example, one party might receive 100 million British pounds (GBP), while the other receives $125
million. This implies a GBP/USD exchange rate of 1.25. At the end of the agreement, they will swap again at
either the original exchange rate or another pre-agreed rate, closing out the deal.

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 Real-World Example

Consider a company that is holding U.S. dollars and needs British pounds to fund a new
operation in Britain. Meanwhile, a British company needs U.S. dollars for an investment in the
U.S.

The two seek each other out through their banks and come to an agreement where they both get
the cash they want without having to go to a foreign bank to get a loan, which would likely involve
higher interest rates and increase their debt loads.

Currency swaps don't need to appear on a company's balance sheet, while a loan would. 

Motives of Internationalisation of Financial Markets

Eurobond Markets and advantages for Borrowers and Investors.