FUNDAMENTALS OF

INTERNATIONAL
FINANCE 
BY
DEEPIKA
RADHIKA
MAYANK
AKHILENDRA
RUSHEEL
PRASHANTH
 INTRODUCTION
 International Finance deals with monetary interactions between two or more
countries, concerning itself with topics such as currency exchange rates,
international monetary systems, foreign direct investment.

 countries often borrow and lend from each other. In such trades, many
countries use their own currencies. Therefore, we must understand how the
currencies compare with each other. Moreover, we should also have a good
understanding of how these goods are paid for and what is the determining
factor of the prices that the currencies trade at.

 The World Bank, the International Finance Corporation (IFC), the International
Monetary Fund (IMF), and the National Bureau of Economic Research (NBER)
are some of the notable international finance organizations.
 IMPORTANCE OF
INTERNATIONAL FINANCE
 International finance is an important tool to find the exchange rates, compare
inflation rates, get an idea about investing in international debt securities,
ascertain the economic status of other countries and judge the foreign markets.
 Exchange rates are very important in international finance, as they let us
determine the relative values of currencies. International finance helps in
calculating these rates.
 Various economic factors help in making international investment decisions.
Economic factors of economies help in determining whether or not investors’
money is safe with foreign debt securities.
 An international finance system maintains peace among the nations. Without a
solid finance measure, all nations would work for their self-interest. International
finance helps in keeping that issue at bay.
FEATURES OF INTERNATIONAL
FINANCE
  Foreign exchange risk
 When different national currencies are exchanged foreach other, there is a
definite risk of volatility in foreign exchange rates.
 The present International Monetary System set up is characterized by a mix of
floating and managed exchange rate policies adopted by each nation keeping in
view its interests.
 In fact, this variability of exchange rates is widely regarded as the most serious
international financial problem facing corporate managers and policy makers.

 Political risk ranges from the risk of loss (or gain) from unforeseen
government actions or other events of a political character such as acts of
terrorism to outright expropriation of assets held by foreigners
 Expanded Opportunity Sets
 When firms go global, they also tend to benefit from expanded
opportunities which are available now.
 They can raise funds in capital markets where cost of capital is the
lowest.
 The firms can also gain from greater economies of scale when they
operate on a global basis.

 Market Imperfections
 domestic finance is that world markets today are highly imperfect
 differences among nations’ laws, tax systems, business practices
and general cultural environments
Foreign Exchange Rates

 A foreign exchange rate is the price of the domestic currency stated in

terms of another currency. In other words, a foreign exchange rate
compares one currency with another to show their relative values
 Currency depreciation is the loss of value of a country's currency with
respect to one reference currencies Currency is an increase in the value of
the currency
 Currencies, unlike stocks, bonds and commodities, can only derive value on
a relative basis against other currencies.  For example, the US Dollar can
increase in value against the Euro while decreasing in value against the
Chinese Yen.  So, currency valuation is always on a relative basis, as it’s a
matter of perspective
 Recently, it has been popularized that investors should invest portions of
their portfolios overseas in developed markets like Europe and developing
markets like Brazil, Russia, India and China-coined the BRIC countries
Why Exchange Rates Might
Move
Exchange rate movements are a reflection of short-term economic conditions and
can occur because of a number of different factors:
 Interest rates – Higher interest rates lead to higher rates of return for investors.
An increase in demand from abroad for these higher rates can translate into
higher value in the domestic currency, and vice versa.
 Trade balance – The balance of trade between imports and exports can impact
the supply and demand for currencies. If a country’s exports exceed its imports
(or the overall pricing of exports rises faster than the pricing of imports), it can
result in greater value for its currency as well.
 Public debt – High levels of government debt can have a negative impact on a
country’s exchange rate. A mountain of debt can create the perception that the
country is in poor financial shape and has the potential of defaulting if it
accumulates debt that it can’t pay off.
 Political environment – A country experiencing political unrest or
governmental instability likely makes for a less attractive investment opportunity.
The markets hate uncertainty, and concerns about the political environment
generally lead to lower value in the domestic currency.
Techniques to reduce Exchange
Rate Risk
Derivative instruments of forex risk management are;
 Forward Contract: A forward contract is a commitment to buy or sell a
specific amount of foreign currency at a later date or within a specific
time period and at an exchange rate stipulated when the transaction is
struck. The delivery or receipt of the currency takes place on the agreed
forward value date.
 Futures
 Options: There are two types of foreign currency options:
Call option gives the holder the right to buy foreign currency at a pre-
determined price. It is used to hedge future payables. Put option gives the
holder the right to sell foreign currency at a pre-determined price. It is used
to hedge future receivables.
 Swaps: In order to hedge long-term transactions to currency rate
fluctuations, currency swaps are used
Example
Cost of Forward Contract

 In this formula, the exchange rate is expressed in terms of domestic

currency units per unit of foreign currency. To illustrate, if the spot price of 1
US dollar is Indian rupees 39.3750 on a given date and its 180-day forward
price quoted is Rs 39.8350, the annualized forward premium works out to
0.92, as under:
 Forward premium or discount = (39.8350 – 39.3750) * 360/180 = 0.92
 The forward differential is known as swap rate. By adding the premium (in
points) to or subtracting the discounts (in points) from the spot rate, the
swap rate can be converted into an outright rate. These forward premiums
and discounts reflect the interest rate differentials between the respective
currencies in the inter-bank market.
 If a currency with higher interest rates is sold forward, sellers enjoy the
advantage of holding on to the higher earning currency during the period
between agreeing upon the transaction and its maturity.
Trade Finance

 Trade finance signifies financing for trade, and it concerns both domestic
and international trade transactions.
It includes:
 Lending facilities
 Issuing Letters of Credit (LCs)
 Export factoring (companies receive funds against invoices or accounts
receivable)
 Forfaiting (purchasing the receivables or traded goods from an exporter)
 Export credits (to reduce risks to funders when providing trade or supply
chain finance)
 Insurance (during delivery and shipping, also covers currency risk and
exposure)
Risks

 Payment risk
 Country risk
 Corporate risk
Eurobond
 The Eurobond is a type of bond that is issued in a currency that is
different from that of the country or market in which it is issued.
Despite its name, it has no particular connection to Europe or the
euro currency.
 Due to this external currency characteristic, these types of
bonds are also known as external bonds.
 The bond raises the money needed in the currency that is needed,
without the forex risk.
 An investor may gain exposure to a foreign market while investing
in an established domestic company.
 Eurobonds are one method of financing a company with foreign
money. By definition, Eurobonds are bonds that are issued in a
currency that is not the domestic currency of the issuer.
 A bond issued by an U.S. company in Australia, denominated in
Australian dollars, would be an example of a Eurobond
Benefits of Eurobond for Issuer
and Investor
 There are a number of benefits to issuing eurobonds rather than domestic bonds for a project of this
type:
 Companies can issue bonds in the country of their choice and the currency of their choice,
depending on what is most beneficial for the planned use.
 The issuer can choose a country with an interest rate that is favorable to its own at the time of the
issue, thus reducing the costs of borrowing.
 Eurobonds have particular appeal to certain investor populations. For example, many U.K. residents
with roots in India, Pakistan, and Bangladesh view investments in their homelands favorably.
 The company reduces forex risk. In the example above, the company could have issued the
domestic bonds in the U.S. in U.S. dollars, converted the amount to Indian rupees at the prevailing
rates in order to move it to India, then exchanged rupees for U.S. dollars in order to pay interest to
bondholders. This process adds transactional costs and forex rate risk.
 Although eurobonds are issued in a particular country, they are traded globally, which helps in
attracting a large investor base.
 For the investor, eurobonds can offer diversification with a smaller degree of risk. They are investing
in a solid and familiar local company that is expanding its business into an emerging market.
 Also, eurobonds are denominated in foreign currencies but launched in nations with strong
currencies. That keeps them highly liquid for their local investors.
Thank You