FOUNDATIONS OF INTERNATIONAL
FINANCIAL MANAGEMENT
International Financial Management
 today’s world and it is also known as
international finance.
 It means financial management in an
international business environment. different
currency
International Monetary System
 institutional framework
 evolved over time
Bimetallism: Before 1875
 gold and silver.
 phenomenon referred to
 Gresham’s Law - Monetary principle
Classical Gold Standard: 1875 – 1914
 until 1821 in Great Britain
• gold alone is assured of unrestricted
coinage,
• there is two-way convertibility
between gold and national currencies
at a stable ratio, and
• gold may be freely exported or
imported.
 Price-Specie-Flow Mechanism
◦ developed by David Hume to trade
imbalances
Interwar Period: 1915 - 1944
 “predatory” to gaining advantages
 half-hearted
Bretton Woods System: 1945–1972
 In July 1944, representatives of 44 nations
 International Bank for Reconstruction and
Development (IBRD), better known as the World
Bank - development projects.
 $35 per ounce.
 This dilemma, known as the Triffin paradox -
collapse of dollar
 President Charles de Gaulle - buy gold from the
U.S. special drawing rights (SDRs),
 In 1963, President John Kennedy imposed the
Interest Equalization Tax (IET)
 In August 1971, President Richard Nixon
suspended the convertibility of dollar into gold
The Flexible Exchange Rate Regime: 1973– Present
 demise of the Bretton Woods system
 The key elements of the Jamaica Agreement
include:
o Flexible exchange rates were declared
acceptable to the IMF members, and
central banks were allowed to intervene
in the exchange markets to iron out
unwarranted volatilities.
o Gold was officially abandoned (i.e.,
demonetized) as an international reserve
asset. Half of the IMF’s gold holdings
were returned to the members and the
other half were sold, with the proceeds
to be used to help poor nations.
o Non-oil-exporting countries and less-
developed countries were given greater
access to IMF funds.
 In September 1985, the so-called G-5 countries
(France, Japan, Germany, the U.K., and the
United States) met Plaza Hotel in New York
and reached what became known as the Plaza
Accord.
 G-7 - Paris in 1987. The meeting produced the
Louvre Accord, according to which:
o The G-7 countries would cooperate to
achieve greater exchange rate stability.
o The G-7 countries agreed to more closely
consult and coordinate their
macroeconomic policies.
Classification of Exchange Rate Arrangements
 No separate legal tender - Monetary control
 Currency board - monetary agreement
 Conventional peg - fixed rate
 Stabilized arrangement - spot market
 Crawling peg - vis-a-vis
 Crawl-like arrangement - narrow margin
 Pegged exchange rate within horizontal bands-
margin fluctuation
 Other managed arrangement - residual
 Floating - predictable
 Free floating - intervention
Balance of Payments
 contains the transactions
 summarizes of payments
Components of Balance of Payments
Current Account
The four major components of the
Current account
 Visible trade
 Invisible trade
 Unilateral transfers to and from
abroad
 Income receipts and payments
Capital Account
◦ deficit in the current account
The three major components of the capital
account:
 ◦ Loans to and Bilateral Development Banks and Agencies
borrowings from is a financial institution set up by one individual country to
abroad finance development projects in developing country and
◦ Investments its emerging market
to/from abroad
◦ Changes in foreign Other Regional Financial Institutions
exchange reserves Financial institutions of neighboring countries established
themselves internationally to pursue and finance activities
Significance of Balance of Payments in areas of mutual interest; most of them are central
 balance of payments data is important to lot of banks, followed by development and investment banks.
users.
 Monetary and fiscal policies are achieve specific INTERNATIONAL BOND MARKETS
objectives
 The international bond market is a market for
Corporate Governance bonds that are traded beyond national
 operational management activities boundaries.

3 Key Principles of Corporate Governance They pull together investors from different countries.=
 Shareholder Primacy
 Transparency  The bonds which are traded in international
 Security bond markets are called international bonds.

Normally, though not always, these bonds are issued

Consequences of Poor Corporate Governance
 set up a system of rules, policies.
Corporate Governance in the Financial Sector
 Governance issues in financial
institutions
 Financial institutions - public's trust and
liquidity shocks
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GLOBAL FINANCIAL MARKETS AND INSTITUTIONS
INTERNATIONAL FINANCIAL INSTITUTION
established more than one country, and subject to
international law.
• Its owners or shareholders are national governments
Types of International Financial Institutions
Multilateral Development Banks
is an institution, created by a group of countries, that
provides financing and professional advice to enhance
development.
Bretton Woods Institutions
The best-known IFIs were established after World War II to
assist in the reconstruction of Europe and provide
mechanisms for international cooperation in managing the
global financial system.
in the issuer's domestic currency. In fact, it depends
on where the subscription is expected.
Classifications of International Bond Markets
FOREIGN BONDS
• In foreign bonds, the issuer is from one country
but he issues the bonds in some other country.
The issuer issues these bonds in the local
currency of the country where he is issuing
bonds.
EURO BONDS
• In Euro Bond, a foreign entity issues a bond in
the domestic market. The issuer issues bond in a
currency which is not the domestic currency of
that country.
GLOBAL BONDS
• Apart from foreign bonds and euro bonds, some
companies, though rarely, issue global bonds. In
global bonds, bonds are issued in multiple
countries at a go and often in multiple
currencies. Usually, large multinational
corporations’ issue global bonds.

Regional Development Banks

consist of several regional institutions that have functions
similar to the World Bank group's activities, but with
particular focus on a specific region.
 areas of a market economy because it gives companies
access to capital and investors a slice of ownership in a
company with the potential to realize gains based on its
future performance.

International equity markets are an important platform for

global finance. They not only ensure the participation of a
wide variety of participants but also offer global
economies to prosper.

Market Structure, Trading Practices, and Costs

• The secondary equity markets provide

marketability and share valuation.

• Investors or traders who purchase shares from

the issuing company in the primary market may
not desire to own them forever.

• The secondary market permits the shareholders

to reduce the ownership of unwanted shares
INTERNATIONAL BOND MARKET and lets the purchasers to buy the stock.

INTERNATIONAL BOND MARKET is a market for bonds KINDS OF ORDERS

that are traded beyond national boundaries. Normally,
these bonds are issued in issues domestic currency.  Market Order
 Limit Order
CLASSIFICATION OF MARKET  Dealer Market
 Agency Market
Foreign Bonds. In foreign bonds, issuer issues bonds in
local currency of the country in which bonds are issued

Euro Bonds. In euro bonds, issuer issues bonds in other
than domestic currency of the country in which bonds are
issued
Global Bonds. In global bonds, issuer issued bonds in
multiple countries & often in multiple currencies.
CROWD TRADING
 is a form of non-continuous trade.
 In crowd trading, in a trading ring, an agent
periodically announces the issue. The traders
then announce their bid and ask prices, and look
for counterparts to a trade.

ADVANTAGES TRADING IN INTERNATIONAL EQUITIES

 A greater global integration of capital markets
 Diversification became apparent for various reasons –
 Increased exposure  First, investors understood the good
 Higher returns effects of international trade.
 Hedging  Second, the prominent capital markets
got more liberalized through the
DISADVANTAGES elimination of fixed trading
commissions.
 Increased risk  Third, internet and information and
 Exchange rate volatility communication technology facilitated
 Lack of liquidity efficient and fair trading in international
stocks.
 Fourth, the MNCs understood the
INTERNATIONAL EQUITY MARKETS advantages of sourcing new capital
International equity markets are the markets in which internationally.
shares are issued and traded, either through exchanges or
over-the-counter markets. Cross-listing refers to having the shares listed on one
or more foreign exchanges. In particular, MNCs do this
Also known as the stock market, it is one of the most vital generally, but non-MNCs also cross-list.

YANKEE STOCK OFFERINGS
 In 1990s, many international companies, including
the Latin Americans, have listed their stocks on U.S.
exchanges to prime market for future Yankee stock
offerings, that is, the direct sale of new equity capital
to U.S. public investors.
 One of the reasons is the pressure
for privatization of companies.
 Another reason is the rapid growth
in the economies.
 The third reason is the expected
large demand for new capital after
the NAFTA has been approved.
AMERICAN DEPOSITORY RECEIPTS (ADR)
 An ADR is a receipt that has a number of foreign
shares remaining on deposit with the U.S.
depository’s custodian in the issuer’s home
market.
 The bank is a transfer agent for the ADRs that
are traded in the United States exchanges or in
the OTC market.
AMERICAN DEPOSITORY RECEIPTS (ADR)
 ADRs offer various investment advantages.
These advantages include –
 ADRs are denominated in dollars, trade
on a US stock exchange, and can be
purchased through the investor’s
regular broker.
 Dividends received on the shares are
issued in dollars by the custodian and
paid to the ADR investor, and a
currency conversion is not required.
 ADR trades clear in three business days
as do U.S. equities, whereas settlement
of underlying stocks vary in other
countries.
 ADR owners can provide instructions to
the depository bank to vote the rights.
AMERICAN DEPOSITORY RECEIPTS (ADR)
 ADRs offer various investment advantages.
These advantages include –
 ADR price quotes are in U.S. dollars.
 ADRs are registered securities and they
offer protection of ownership rights.
Most other underlying stocks are
bearer securities.
 An ADR can be sold by trading the ADR
to another investor in the US stock
market, and shares can also be sold in
the local stock market.
 ADRs frequently represent a set of
underlying shares. This allows the ADR
to trade in a price range meant for US
investors.
AMERICAN DEPOSITORY RECEIPTS (ADR)
 There are two types of ADRs: sponsored and
unsponsored.
 Sponsored ADRs are created by a bank after a
request of the foreign company.
 Unsponsored ADRs are generally created on
request of US investment banking firms without
any direct participation of the foreign issuing
firm.
GLOBAL REGISTERED SHARES (GRS)
 GRS are a share that are traded globally, unlike
the ADRs that are receipts of the bank deposits
of home-market shares and are traded on
foreign markets. The GRS are fully transferrable
— GRS purchased on one exchange can be sold
on another.
MACROECONOMIC FACTORS
 Solnik (1984) examined the effect of exchange
rate fluctuations, interest rate differences, the
domestic interest rate, and changes in domestic
inflation expectations. He found that
international monetary variables had only weak
influence on equity returns.
 Asprem (1989) stated that fluctuations in
industrial production, employment, imports,
interest rates, and an inflation measure affect a
small portion of the equity returns.
EXCHANGE RATES
 Adler and Simon (1986) tested the sample of
foreign equity and bond index returns to
exchange rate changes. They found that
exchange rate changes generally had a variability
of foreign bond indexes than foreign equity
indexes.
INDUSTRIAL STRUCTURE
 Roll (1992) concluded that the industrial
structure of a country was important in
explaining a significant part of the correlation
structure of international equity index returns.
 Heston and Rouwenhorst (1994) stated that
“industrial structure explains very little of the
cross-sectional difference in country returns
volatility, and that the low correlation between
country indices is almost completely due to
country-specific sources of variation.”
INTEREST RATES AND CURRENCY SWAPS
 Swaps are derivative contracts between two
parties that involve the exchange of cash flows.
 One counterparty agrees to receive one set of
cash flows while paying the other another set of
cash flows.
  Interest rate swaps involve exchanging interest POLICIES FOR FOREIGN PORTFOLIO INVESTMENT
payments, while currency swaps involve  Foreign portfolio investment is inherently volatile,
exchanging an amount of cash in one currency and rigorously regulated financial markets are
for the same amount in another. needed to manage the risk effectively.
Furthermore, the financial system must be capable
INTEREST RATE SWAPS of identifying and mitigating risks for prudent and
 An interest rate swap is a financial derivative efficient allocation of foreign or domestic capital
contract in which two parties agree to exchange flows.
their interest rate cash flows. The interest rate
swap generally involves exchanges between FOREIGN PORTFOLIO INVESMENT
predetermined notional amounts with fixed and
floating rates.  is inherently volatile, and rigously regulated financial
markets are needed to manage the risk effectively.
CURRENCY SWAPS
 Currency swaps are a foreign exchange
agreement between two parties to exchange
cash flow streams in one currency to another.
While currency swaps involve two currencies,
interest rate swaps only deal with one currency.

INTERNATIONAL FOREIGN INVESTMENTS

 International foreign investments (IFF) or
Foreign portfolio investment (FPI) involves an
investor purchasing foreign financial assets. The
transaction of foreign securities generally occurs
at an organized formal securities exchange or
through an over-the-counter market transaction.

BENEFITS OF FOREIGN PORTFOLIO INVESTMENT

The primary BENEFITS OF FOREIGN PORTFOLIO
INVESTMENT
1. portfolio diversification
2. International credit
3. Access to market with different risk-return
characteristics
4. Increases the liquidity of domestic capital markets
5. Promotes the developments of equity markets

RISKS OF FOREIGN PORTFOLIO INVESTMENT (FPI)

 Volatile asset pricing
 Jurisdictional risk

FINANCIAL ASSETS FOR FOREIGN PORTFOLIO

INVESTMENTS
 The typical financial assets that can be
purchased through foreign portfolio investment
include equities, bonds, and derivative
instruments.
 These securities can be purchased for many
reasons; however, generally, foreign portfolio
investment is positively influenced by high rates
of return and reduction of risk through
geographic diversification.