International Finance

- Nikhilesh N w ni
a
a
 • 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.
ff

fi
fi

fi

fi
 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
fl

ff
ff

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.
ff

fi

 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.
fi
ff

fi

fi
fi

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.
fi
ff

fl

fi
fl

fi
fl
fi
ff

ffi

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

ff
fi

fi
fi

ffi
ffi

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
fi
fi

fi

fi

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.
fi

fl

fl
fl
fi
ft

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.

fi
fl

fl

 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
fl
fl

 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.
ff
fi

ff
ff

 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.

 Examples:

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.

fi