28679324 international financial management 1
TRANSCRIPT
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
Issues & Dimensions (Scope) of IFM
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
Issues & Dimensions (Scope) of IFM
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
Issues & Dimensions (Scope) 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
Issues & Dimensions (Scope) of IFM
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.
Issues & Dimensions (Scope) of IFM
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.
Issues & Dimensions (Scope) of IFM
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
Issues & Dimensions (Scope) of IFM
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>>
PARTICULARS CREDIT DEBIT Net (+) / (-)
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>>
PARTICULARS CREDIT DEBIT Net (+) / (-)
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>>
PARTICULARS CREDIT DEBIT Net (+) / (-)
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
PARTICULARS CREDIT DEBIT Net (+) / (-)
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
Leads to BOP Disequilibrium (Surplus or Deficit)
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
Leads to BOP Disequilibrium (Surplus or Deficit)
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 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
Devaluation 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
Decrease in Money Supply
Devaluation of Currency
Exchange Control
Export Promotion
Import Control
Foreign Loan
FDI and FII
Inward Transfers
Import Substitution
Promote Tourism