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INTERNATIONAL FINANCIAL ENVIRONMENT

MULTINATIONAL CORPORATION (MNC) FOREIGN EXCHANGE MARKETS Dividend remittance and financing
Exporting & importing

Investing financing

Product markets

subsidiaries

International financial Market

The importance of multinational corporations and the globalization of production are now well recognize. Multinational Corporations (MNC) have become central actors of the world economy and in linking foreign Direct investment, trade, technology and Finance, they are a driving force of economic growth. Since the world is reduced to an electronic village and Global Finance has become a reality therefore in a contemporary global financial corporation capital is one of the most fungible assets to cross national boundaries. The determinants of the way in which transnational corporation acquire, organize and manage those assets is of critical importance, not only to the success of those corporations, but also to the development and industrial restructuring of nation states. The task of an international Financial Manager is to make the best possible tactical decision that the market has to offer on liabilities within the strategic funding constraints.

International Financial Management With the opening up of the markets. overseas involvement of Indian firms is increasing and this trend is expected to continue. more and more finances are being sought from international capital markets and export efforts are being intensified to earn foreign exchange. To grapple with these problems one needs an under standing of International financial management. Basic decisions to be taken by the Finance managers under international financial management can be groped as : . Many projects are being set up abroad.

1. International taxation 4. Current Asset management 2. Financing foreign trade . Investment decision 2. International capital under taking 5. Managing forex risks 3. International accounting 7. Financing decision 6. Asset management decisions Scope of International Financial Management 1. Financing decision and 3.

b. . works in progress. Current Asset Management constitutes of : a. Inventory Management Refers to the management of supplies. Cash Management b. Inventory Management Cash Management aims at minimizing cash balance Accounts receivable management aims at management of creditors and collection of amount receivable. c. raw material.1. finished goods. a. Accounts receivable management c.

Translation exposes : Occurred when statement of account of host country figures are converted into home country currency and converted into home country currency and profits many turn into losses because of sudden changes in the currency rates. Economic exposure : Occurs because of adverse economic environment in host country. b. The company may face the risk of losing the forecasted earning / profits. . c. a.2. Transaction exposure : occurs when a company faces a huge loss / profit in a single shot due to forex fluctuations. Managing Foreign exchange risk Multinational companies face three types of risks.

Planning capital structure .Managing flow of funds The problems here are ± . 3.making foreign investments . options swaps. International taxation ± Has a significant effect on .Double taxation and transfer pricing .Techniques to over come the risks : Forwards and derivatives ± futures.Managing exchange risks .

4.Estimating future cash in flows .Evaluating the profitability and selection of best alternative. Financing decision Involved decision regarding the .Discounting future in flows into present value . 5.Capital structure of the host county subsidiary.Sources of financing the subsidiary (debt / equity) . . International capital budgeting The steps involved in international capital budgeting are. .

Optimal capital structure . Financing foreign trade It foreign affiliate requires financing through long term funds and short term funds.Translating the reported operations of foreign subsidiaries into currency of the parent firm for consolidating financial statement.Accounting transactions in foreign currencies. 7. .Sources of funds .6.Parent company¶s stake in equity . The key issues with respect to financing foreign operations are ± . . International accounting Firms engaged in international business face two specific accounting problem.

Interest rates and exchange rates. Management of Assets ± from cash management to international cash budgeting. 2. markets. . in domestic and foreign currencies. Forecasting the Financial Environment ± prices. in domestic and foreign currencies. Exchange risk management ± measuring the effect of exchange rate changes on balance sheets. 4. Inflation rates. and cash flows. income. 5. Performance evaluation and control ± accounting for outsiders. Management of liabilities ± borrowing relationship and decisions. short term and long term. at home and abroad. tax authorities and for management and doing so across countries and currencies without distortion. and managing these risks.ROLE OF INTERNATIONAL FINANCIAL MANAGER The Chief tasks of the International Financial Manager are summarized as under :1. Sounds like Herculean agenda ? Yes. 3.

Economic Frame work of international financial Management Disequilibrium conditions Relative excess Money supplies 1 Relative inflation rate 2 3 4 Rate of Change of Exchange rate 6 Relative interest rates Forward Premium 5 .

IFM ± FINANCE FUNCTION Finance Function of a firm can be divided into two sub functions a) Control and Accounting b) Treasury Treasurer Controller Financial Planning Analysis Cash Mgmt External Reporting Financial Mgmt Accounting Funds acquisition Funds acquisition Tax planning Management Budget Planning control Budget Planning control Risk Management Management information system Accounts receivable .

EXHIBIT ± 1 THE INTERNATIONAL FINANCIAL SYSTEM Domestic Financial System System Country A International Financial System Domestic Financial Unique Elements Markets Country B Markets Money market Bond market Equity market Markets Money market Bond market Equity market Foreign exchange market Eurocurrency market Eurobond market Forward and future markets for foreign exchange Participant Individual Corporations Governments Intermediaries Brokers Participants Domestic participants from country A Domestic participants from country B International public financial or Welfare organizations Participant Individual Corporations Governments Intermediaries Brokers .

EXCHANGE RATE SYSTEMS ‡ The exchange rate is formally defined as the value of one currency in terms of another. . floating. Exchange rates may be fixed. Different system have different methods of correcting the disequilibrium between international payments and receipts. or with limited flexibility. Different mechanisms will be discussed in subsequent sections. There are different ways in which the exchange rates can be determined.

. Examples of this system are the gold standard and the Bretton Woods System.Target zone arrangement (also called currency block) Monetary union. The fixed exchange rates results from countries pegging their currencies to either some common commodity or to some particular currency. The particular variation of the fixed rate system are : Fixed (or pegged) exchange rate systems include: . These rates are determined by governments or the Central Banks of the respective countries. under a fixed (or pegged) exchange rate system the value of a currency in terms of another is fixed.Fixed Exchange rate System As the name suggests.Currency board system . There is generally some provision for correction of these fixed rates in case of a fundamental disequilibrium.

To prevent such an event. called the currency board. Due to pegging. and its exchange rate in terms of other currencies depends on the exchange rates between the other currencies and the currency to which the domestic currency is pegged. a country fixes the rate of its domestic currency in terms of a foreign currency. It commits to convert its domestic currency on demand into the foreign anchor currency to an unlimited extent. An internationally accepted. thus forcing the authorities to either change. or altogether abandon the peg. the monetary policies are kept in lime with that of the reference country by the central monetary authority. the monetary policies and economic variables of the country of the reference currency are reflected in the domestic economy. The currency board maintains reserves of the anchor currency up to 100% or more of the domestic currency in circulation. This may result in a run on the currency. These reserves are generally held in the form of low-risk.CURRENCY BOARD SYSTEM ‡ Under a currency board system. there is a pressure on the exchange rate to change accordingly. interest bearing assets denominated in the anchor currency. . relatively stable currency is generally selected as the anchor currency. at the fixed exchange rate. If the fundamentals of the domestic economy show a wide disparity with that of the reference country¶s.

This system is called a target zone arrangement. Convergence of economic policies of the participating countries is a prerequisite for the sustenance of this system. and agrees to maintain the exchange rates between their currencies within a certain band around fixed central exchange rates. An example of this system is the European Monetary System under which twelve countries came together in 1979. and attempted to maintain the exchange rates of their currencies with other member countries¶ currencies within a fixed band around the central exchange rate.TARGET ZONE ARRANGEMENT ‡ A group of countries sometimes gets together. .

The economic variables of the member countries have to be quite proximate for the system to be viable. a group of countries agree to use a common currency. which has the sole authority to issue currency and to determine the monetary policy of the group as a whole. the region as a whole experiences the same inflation rate.MONETARY UNION ‡ Monetary union is the next logical step of target zone arrangement. The member countries lose the power to use economic variables like interest rates to adjust their economies to the phase of economic cycle being experienced by them. An independent. This eliminates the variability of exchange rates and the attendant inefficiencies completely. As a result. This is the most extreme form of management of exchange rates. Common Central Bank is set-up. instead of their individual currencies. Under this system. .

in turn. Hence. the exchange rates between currencies are variable.Floating Exchange Rate System Under this system. Floating exchange rates can be of two types : Free flat and Managed float. Floating exchange rates can be of two types : Free float and Managed float. which may either result due to international trade in goods or services. These. interest rates and economic growth of the countries are some of the factors which result in such imbalances). depend on the flow of money between the countries. the exchange rates get automatically adjusted and this leads to a correction in the imbalance. . in case of a deficit or surplus in the Balance of Payments (difference between the inflation rates. or due to purely financial flows. These rates are determined by the demand and supply for the currencies in the international market.

There is no intervention at all either by the government or by the Central Bank. a lot of volatility is observed in the markets following a free float system. changes the equilibrium in the currency market and the exchange rate is determined accordingly. This. . in turn. as the market receives. and even a moment ± to ± moment basis . political and social news. The current and expected future demand and supply of currencies change on a day ± to ± day. Hence. analyzes and reacts to economic.FREE FLOAT The exchange rate is said to be freely floating when its movements are totally determined by the market. As the reactions to events do not follow a set pattern. the resultant movements in the exchange rates turn out to be quite random. This system is also known as the clean float.

The aim may be to avoid fluctuations which may not be in accordance with the underlying economic fundamentals. ii. in accordance with the fundamentals. thus unofficially keeping it fixed. iii. Some events are liable to have only a temporary effect on the markets. . in reality the Central Bank may intervene regularly in the currency market. and speculative attacks on the currency. In the third variation. while letting the markets find their own equilibrium rates in the long-term. intervention may take place to prevent these short and medium-term effects. The Central Bank may occasionally enter the market in order to smoothen the transition from one rate to another.MANAGED FLOAT This management of exchange rates can take three forms : i. though officially the exchange rate may be floating. while allowing the market to follow its own trend. In the second variation.