28679324 international financial management 1

UNIT I

INTERNATIIONAL FINANCIAL MANAGEMENT

Syllabus to be covered in Unit I Introduction to International Economic

Environment Issues and Dimensions of IFM Comparative Advantage Theory of Trade International Financial Flows Balance of Payment International Securities Market

ADR, GDR, Euro Bonds India’s Experience in International Capital

Market

Evolution & Growth of IFM

Slow but Steady growth of International Trade till 1940s

GATT was signed in 1949 – Gave a huge boost to International Trade

Second half of Twentieth Century witnessed the fast expansion of MNCs due to LPG in world

Increased role of International Financial Agencies like WTO, IMF, World Bank etc.

Value of World Trade grew from US$ 60 billions during 1950 to US$ 5.4 Trillions in late 90s.

International Financial Management

In what contexts International Business (Transactions) is

different from Domestic Business (Transactions)

How Domestic FM is different from IFM Firm must deal with multiple currencies Much richer menu of options to choose

long- or short-term funding Wider menu of options to park surplus funds Firms exposes to two new risks, viz.

exchange rate risk and political risk Different accounting practices, standards

and tax laws Longer Distance and Time involved in

International Transactions

How FM is different from IFM

To summarize managing the finance function in a multinational context involves wider, opportunities, more

varied risks, multiplicity of regulatory environments and, as a

Consequence, increased complexity in decision-making.

International Financial Management – Concept

International Financial Management deals with the financial decisions

taken in the area of International Business.

It helps in taking the correct financial decision so that maximum gain my be derived from International Business.

Issues & Dimensions (Scope) of IFM

Issues, Dimensions or Scope of International Financial

Management consists of all the functions, activities or decision

regarding Financial Management of International Business

Issues & Dimensions (Scope) of IFM Foreign Exchange Market Exchange Rate Determination Exchange Rate Risk & its Management MNC’s Investment Decision Financing Decisions of the MNC’s International Working Capital Decision International Accounting International Indebtness Various International Financial Agencies

WTO, IMF & World Bank


Foreign Exchange Market As Importers has to make payment in

foreign currencies

Exports needs to convert foreign currency in domestic currency

Therefore, need emerges to understand Foreign Exchange Market, while dealing with Imports and Exports i.e. International Business


Exchange Rate Determination Another matter related to IFM is as to how

exchange rates will be decided

Generally exchange rate between two currencies are decided in open market on the basis of

Mainly DEMAND & SUPPLY of both currencies And Some Macro Variable Factors like Rate of Interest, Political

Stability etc.

IMF plays an important role in exchange rate determination

All these form subject matter of IFM


Exchange Rate Risk Management As Exchange Rate Determination is based on

Demand & Supply, and change frequently

It Leads to Exchange Rate Fluctuation Risk for Genuine Users like Exporters and Importers

Which they Manage by HEDGING

At the same time this fluctuation makes scope for profiteering: By Speculators By Arbitrators


MNC’s Investment Decisions While taking decision of International

Investment, a MNC’s primarily looks for Positive Net Cash Inflows

Beside this it has to look other factors like Exchange Rate Risk Political Risk

IFM thus studies different theories, techniques and strategies for investment, capital budgeting and project appraisal.


Financing Decision of MNCs MNCs have easy access to international

sources of finance, which includes International Development Banks (WB, ADB) Eurocurrency Market International Securities Market (ADR, GDR)

With the availability of such wide sources they can minimize the cost of capital and risk.

IFM also studies this area of decision

Issues & Dimensions (Scope) of IFMInternational Working Capital Decision Like long-term finance MNCs do have wide

access to source of working capital

Apart from these sources, they can use various techniques of International Working Capital Management

Special focus is required to optimize the need of working capital as reduces profitability

IFM helps in taking such decision more effectively.


International Accounting MNCs are required to consolidate its

financial statement of different countries at the end of FY

It require to comply with accounting and tax rules of various countries

Therefore, International Financial Manager must be aware of all those rules and policies


International Indebtness Funds inflows and outflows from various

countries on various accounts are recorded as a statement known as BALANCE OF PAYMENT

This statement tells whether in net a country have to pay to other country or receive from other country

In case of payment borrowing has to be done increasing the indebtness of country

All this is also studied under IFM

Issues & Dimensions (Scope) of IFMVarious International Financial Agencies World Trade Organization (WTO)

Established on 1st January 1995 For Regulating and developing the International

Trade

International Monetary Fund (IMF) Established on 27th December, 1945 For Facilitating the International Payments and

Exchange Markets

World Bank Established in 1944 and Operation on 25th June,

1946 For Providing the long-term fund for development

International Financial Flows

International Financial Flows means reasons behind flow of

money between courtiers

International Financial Flows Trade Flows Flow of Services Unilateral Transfers Direct Investment Abroad Portfolio Investment Abroad Short Term Capital Flows

Trade Capital Arbitrage Speculative Flows

International Financial FlowsTrade Flows Flows due to buying and selling of

tangible goods For example: India imports (buys) crude

oil from Arab countries and capital goods from developed countries

Similarly, India exports (sells) precious metal, handicraft to USA, Japan, USSR etc.

Trade Flows takes place due to comparative advantage to various countries to produce various commodities

International Financial FlowsFlow of Services Services means intangible goods like

transportation, banking, education, insurance etc.

When trade takes place in these, intangible goods it is flow of services

Main flow in world takes place due to travel, transport and banking services.

International Financial FlowsUnilateral Transfers Voluntary transfer of fund by resident of

a country to resident of other country

Includes: Gifts, donations, grants etc. Can be by Govt. or Private

Example: Pension paid to foreign employees, money transfer by a person to his family etc.

International Financial FlowsDirect Investment Abroad Purchase of Capital Goods in one country

by the resident of other country

Establishment of a Subsidiary Firm, Branch etc.

Importance part is that in Direct Investment is characterized by Investment + Management.

International Financial FlowsPortfolio Investment Abroad Investment in the securities like debenture,

shares, MF of a country by the resident of other country in expectation of returns

Purchase of Shares, Debentures of India firm by US Resident

Money lending by World Bank or Bank of America to an Indian Firm

Characterized by just Investment, not Management

International Financial FlowsShort-Term Capital Flows Less than 1 Year

In form of export credit, bank deposit, commercial papers etc.

Can be divided in three categories: Trade Capital: Because of Int. Trade like export

credit Arbitrage: For earning profit from market

imperfection Speculative Flow: For earning profit from future

prediction

BALANCE OF PAYMENT

Unit I

Balance of Payment

Balance of Payment (BoP) is a systematic record of all economic

transactions between the residents of a given country

and the residents of other countries – the rest of world,

carried out in a specific period of time.

Balance of Payment

The balance of payments of a country summarizes all the transactions that have

taken place between its residents and foreigners in a given period, usually a year.

The word transactions refers to exports and imports of goods and services; Unilateral Transfers Direct and Portfolio Investment lending and borrowing of funds;

Balance of Payment Accounting Principle of Double Entry Accounting is follows

i.e. for each debit there will be corresponding credit and vice versa

BoP – neither Income Statement not Balance Sheet, but a statement of Recipts and Payments

Any transaction which leads to INFLOWS (Sources) of funds, is CREDITED and transactions which leads to OUTFLOWS (Uses) of funds is DEBITED

Balance of Payment AccountingExamples: CREDIT TRANSACTIONS (+):

Goods and Services Exported Interest received from foreign investment Unilateral Transfers Received from Abroad Investment received from abroad Loans or Borrowing from abroad

DEBIT TRANSACTIONS (-): Goods and Services Imported Interest paid on foreign investment Unilateral Transfers to foreigners Investment by residents in abroad Load given to foreign citizens

Balance of Payment Statement Divided into three parts:

Current Account Consists of all items of revenue nature

which do not make any assets or liabilities like export, import,

Capital Account

Official Reserve Account

Balance of Payment StatementCurrent Account

PARTICULARS CREDIT DEBIT Net (+) / (-)

1. Current Account Transaction

1.1 Merchandise Exports ImportsBalance of Trade

1.2 Services / Factor Income Exports Imports Net

1.3 Unilateral Transfers Receipts Payment Net

Balance on Current Account Sum of Above

<<See the Working of Current Account in BOP>>

Balance of Payment StatementCapital Account

<<See the Working of Capital Account in BOP>>


2. Capital Account Transaction

2.1 Direct Investment From Abroad To Abroad Net

2.2 Portfolio Investment From Abroad To Abroad Net

2.3 Other Capital Borrowing Lending Net

Balance on Capital Account

Sum of Above

Balance of Payment StatementBalance of Payment

<<See the Working of BOP>>


BALANCE OF PAYMENT

Balance on Current Account From Current Account

Balance on Capital Account From Capital Account

Balance of Payment Sum of Above

Balance of Payment StatementOfficial Reserve Account

<<See the Working of Official Reserve Account in BOP>>


Balance on Current Account From Current Account

Balance on Capital Account From Capital Account

Balance of Payment Sum of Above

Official Reserve Account(To set-off the BOP)

To set-off the Deficit

To set-off the Surplus ZERO Balance

Balance of Payment StatementFormat

Balance of Payment Format


1. Current Account Transaction

1.1 Merchandise Exports Imports Balance of Trade

1.2 Services / Factor Incomes Exports Imports Net

1.3 Unilateral Transfers Exports Imports Net

Balance on Current Account Sum of Above

2. Capital Account Transaction

2.1 Direct Investment From Abroad To Abroad Net

2.2 Portfolio Investment From Abroad To Abroad Net

2.3 Other Capital Borrowing Lending Net

Balance on Capital Account Sum of Above

Balance of PaymentSum of Balance on Current Account and Balance on

Capital Account [Surplus (+) / Deficit (-) ]

Official Reserve Account To set-off the Surplus or Deficit in BoP

BOP Disequilibrium

BOP is said to be in equilibrium when Debit = Credit (No Surplus and No Deficit)

BOP is said to be in disequilibrium when either there is Surplus or Deficit

Or when Demand of Foreign Exchange is greater than supply (Case of Deficit)

Or when Supply of Foreign Exchange is greater than Demand (Case of Surplus)

BOP Disequilibrium - Causes

Factors Causing BOP Disequilibrium

Economic Factors Political Factors Social Factors

Development Disequilibrium

Cyclical Disequilibrium

Structural Disequilibrium

BOP DisequilibriumEconomic Factors – Development Disequilibrium

Large Scale Development of Economy

Increase in Demand of

Capital Good

Increase in Demand of Final Good

Increase in IMPORTS

BOP Dis-Equilibrium

BOP DisequilibriumEconomic Factors – Cyclical Disequilibrium

Business Cycles (Boom)

Increase in Demand of Final Good

Increase in IMPORTS

Decrease in EXPORTS

BOP Dis-Equilibrium

Business Cycles

(Depression)

Decrease in Demand of Final Good

Decrease in IMPORTS

Increase in EXPORTS

BOP Dis-Equilibrium

BOP DisequilibriumEconomic Factors – Structural Disequilibrium Some structural changes like

Development of Alternative Sources of Supply Development of substitutes Exhaustion of productive resources etc.

May change the Import and Export composition

Leads to BOP Disequilibrium (Surplus or Deficit)

BOP DisequilibriumPolitical Factors

Certain Political Factors like Political Instability Position of War Weak Economic Position etc.

May lead to large capital outflows from the country Less capital inflows to the country


BOP DisequilibriumSocial Factors

Some Social Changes like Change in taste and preferences Living of standard Patter of living etc.

May change the Import and Export composition


Correction of BOP Disequilibrium

CORRECTION OF DISEQUILIBRIUM

Automatic Correction

Deliberate Correction

MiscellaneousTrade MeasuresMonetary Measures

Decrease in Money Supply

Devaluation of Currency

Exchange Control

Export Promotion

Import Control

Foreign Loan

FDI and FII

Inward Transfers

Import Substitution

Promote Tourism

Correction of BOP DisequilibriumAutomatic CorrectionDeficit in BOP

Increase in Demand of Foreign Exchange

(like $)

Increase in Prices of Foreign Exchange

like from

Rs.40/$ to Rs.50/$

Exports Become Cheaper & Imports become Costlier

Mr. A (an exporter) exporting goods @ $1/ unit

If earlier price were Rs.40/$, he was getting Rs.40/unit

If now price is Rs.50/$, he is getting Rs.50/unit

Mr. B. (an importer) importing goods @ $1/ unit

If earlier price were Rs.40/$, he was paying Rs.40/unit

If not price is Rs.50/$, he is paying Rs.50/unit

WHENEVER PRICE OF FOREING EXHCHANGE INCREASES, EXPORTS

BECOME CHEAPER, IMPORT BECOME COSTLIER

LEADS TO EQUILIBRIUM IN

BOP

Correction of BOP DisequilibriumAutomatic CorrectionSurplus in BOP

Increase in Supply of Foreign Exchange

(like $)

Decrease in Prices of Foreign Exchange

like from

Rs.50/$ to Rs.40/$

Exports Become Costlier & Imports become Cheaper

Mr. A (an exporter) exporting goods @ $1/ unit

If earlier price were Rs.50/$, he was getting Rs.50/unit

If now price is Rs.40/$, he is getting Rs.40/unit

Mr. B. (an importer) importing goods @ $1/ unit

If earlier price were Rs.50/$, he was paying Rs.50/unit

If not price is Rs.40/$, he is paying Rs.40/unit

WHENEVER PRICE OF FOREING EXHCHANGE DECREASES, EXPORTS

BECOME COSTLIER, IMPORT BECOME CHEAPER

LEADS TO EQUILIBRIUM IN

BOP

Correction of BOP DisequilibriumDecrease in Money Supply


Decrease in Domestic Demand

Decrease in Prices

Leads to Equilibrium in BOP

Decrease in IMPORTS

Increase in EXPORTS

Correction of BOP DisequilibriumDevaluation of Currency


Import become Costlier

Exports become Cheaper

Leads to Equilibrium in BOP

Decrease in IMPORTS

Increase in EXPORTS

“Devaluation means reduction in the official rate at which one currency can be exchanged for another currency”

Correction of BOP DisequilibriumExchange Control In extreme situations, Central Bank can

exercise its control over Foreign Currency

Exporter when gets the payment, have to deposit it with Central Bank

Importer when needs the currency, have to get it issued by Central Bank

Purpose is to control the imports

Correction of BOP Disequilibrium

CORRECTION OF DISEQUILIBRIUM

Automatic Correction

Deliberate Correction

MiscellaneousTrade MeasuresMonetary Measures



Exchange Control

Export Promotion

Import Control

Foreign Loan

FDI and FII

Inward Transfers

Import Substitution

Promote Tourism

28679324 international financial management 1

Documents

international transactions

gdr international

area of international

exchange rate fluctuation

profitability ifm

financial decisions

exchange rates

correct financial decision