SIKKIM MANIPAL UNIVERSITY
DEPARTMENT OF DISTANCE EDUCATION
ASSIGNMENT
SEMESTER 4
NAME : ABHISHEK JAIN
ROLL NUMBER : 511035358
LEARNING CENTER : 02882
SUBJECT NAME :
INTERNATIONAL BUSINESS
MANAGEMENT (MB0053)
MODULE NO : SET 1
DATE OF SUBMISSION AT THE
LEARNING CENTRE : 31-MAY-11
FACULTY SIGNATURE :
MBA 4th Sem Assignment International Business Management – MB0053 – Set 1
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Master of Business Administration-MBA Semester 4
International Business Management – MB0053 Assignment Set - 1
Q.1 What is globalization? What are its benefits? How does globalization help in international
business? Give some instances?
Ans : Globalization (or globalisation) describes the process by which regional economies, societies,
and cultures have become integrated through a global network of political ideas through
communication, transportation, and trade. The term is most closely associated with the term
economic globalization: the integration of national economies into the international economy
through trade, foreign direct investment, capital flows, migration, the spread of technology, and
military presence. However, globalization is usually recognized as being driven by a combination of
economic, technological, sociocultural, political, and biological factors. The term can also refer to
the transnational circulation of ideas, languages, or popular culture through acculturation. An
aspect of the world which has gone through the process can be said to be globalized.
Against this view, an alternative approach stresses how globalization has actually decreased inter-
cultural contacts while increasing the possibility of international and intra-national conflict.[3]
Globalization has various aspects which affect the world in several different ways
Industrial - emergence of worldwide production markets and broader access to a range of
foreign products for consumers and companies. Particularly movement of material and
goods between and within national boundaries. International trade in manufactured goods
increased more than 100 times (from $95 billion to $12 trillion) in the 50 years since
1955.China's trade with Africa rose sevenfold during 2000-07 alone.
Financial - emergence of worldwide financial markets and better access to external
financing for borrowers. By the early part of the 21st century more than $1.5 trillion in national
currencies were traded daily to support the expanded levels of trade and investment
Economic - realization of a global common market, based on the freedom of exchange of
goods and capital
Job Market- competition in a global job market. In the past, the economic fate of workers
was tied to the fate of national economies. With the advent of the information age and
improvements in communication, this is no longer the case. Because workers compete in a
global market, wages are less dependent on the success or failure of individual economies.
This has had a major effect on wages and income distribution
Political - some use "globalization" to mean the creation of a world government which
regulates the relationships among governments and guarantees the rights arising from social
and economic globalization. Politically, the United States has enjoyed a position of power
among the world powers, in part because of its strong and wealthy economy. With the
influence of globalization and with the help of the United States’ own economy, the People's
Republic of China has experienced some tremendous growth within the past decade. If
China continues to grow at the rate projected by the trends, then it is very likely that in the
next twenty years, there will be a major reallocation of power among the world leaders.
China will have enough wealth, industry, and technology to rival the United States for the
position of leading world power.
Most of us assume that international and global business are the same and that any company that
deals with another country for its business is an international or global company. In fact, there is a
considerable difference between the two terms.
International companies – Companies that deal with foreign companies for their business are
considered as international companies. They can be exporters or importers who may not have any
investments in any other country, apart from their home country.
Global companies – Companies, which invest in other countries for business and also operate from
other countries, are considered as global companies. They have multiple manufacturing plants
across the globe, catering to multiple markets.
The transformation of a company from domestic to international is by entering just one market or a
few selected foreign markets as an exporter or importer. Competing on a truly global scale comes
later, after the company has established operations in several countries across continents and is
racing against rivals for global market leadership. Thus, there is a meaningful distinction between a
company that operates in few selected foreign countries and a company that operates and
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markets its products across several countries and continents with manufacturing capabilities in
several of these countries.
Companies can also be differentiated by the kind of competitive strategy they adopt while dealing
internationally. Multinational strategy and global competitive strategy are the two types of
competitive strategy.
Multinational strategy – Companies adopt this strategy when each country’s market needs to be
treated as self contained. It can be for the following reasons:
o Customers from different countries have different preferences and expectations about a
product or a service.
o Competition in each national market is essentially independent of competition in other
national markets, and the set of competitors also differ from country to country.
o A company’s reputation, customer base, and competitive position in one nation have
little or no bearing on its ability to successfully compete in another nation.
o Some of the industry examples for multinational competition include beer, life insurance,
and food products.
Global competitive strategy – Companies adopt this strategy when prices and competitive
conditions across the different country markets are strongly linked together and have common
synergies. In a globally competitive industry, a company’s business gets affected by the
changing environments in different countries. The same set of competitors may compete against
each other in several countries. In a global scenario, a company’s overall competitive
advantage is gauged by the cumulative efforts of its domestic operations and the international
operations worldwide.
A good example to illustrate is Sony Ericsson, which has its headquarters in Sweden, Research and
Development setup in USA and India, manufacturing and assembly plants in low wage countries like
China, and sales and marketing worldwide. This is made possible because of the ease in transferring
technology and expertise from country to country.
Industries that have a global competition are automobiles, consumer electronics (like televisions,
mobile phone), watches, and commercial aircraft and so on.
Table 1 portrays the differences in strategies adopted by companies in international and global
operations.
Table 1: Differences between International and Global Strategies
Strategy International Global
Location Selected target countries and
trading areas
Most global businesses operate in North America,
Europe, Asia Pacific, and Latin America
Business Custom strategies to fit the
circumstances of each host
country situation
Same basic strategy worldwide with minor country
customisation where necessary
Product-line Adopted to local culture and
particular needs and expectations
of local buyers
Mostly standardised products sold worldwide,
moderate customisation depending on the
regulatory framework
Production Plants scattered across many host
countries, each producing
versions suitable for the
surrounding environment
Plants located on the basis of maximum competitive
advantage (in low cost countries close to major
markets, geographically scattered to minimise
shipping costs, or use of a few world scale plants to
maximise economies of scale)
Source of supply
of raw materials
Suppliers in host country preferred Attractive suppliers from across the world
Marketing and
distribution
Adapted to practices and culture
of each host country
Much more worldwide coordination; minor
adaptation to host country situations if required
Cross country
connections
Efforts made to transfer ideas,
technologies, competencies and
capabilities that work successfully
in one country to another country
whenever such a transfer appears
advantageous
Efforts made to use almost the same technologies,
competencies, and capabilities in all country
markets (to promote use of a mostly standard
strategy), new successful competitive capabilities
are transferred to different country markets
Company
organisation
Form subsidiary companies to
handle operations in each host
All major strategic decisions closely coordinated at
global headquarters; a global organisational
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country; each subsidiary operates
more or less autonomously to fit
host country conditions
structure is used to unify the operations in each
country
Benefits of globalisation
We have moved from a world where the big eat the small to a world where the fast eat the slow", as
observed by Klaus Schwab of the Davos World Economic Forum. All economic analysts must agree
that the living standards of people have considerably improved through the market growth. With the
development in technology and their introduction in the global markets, there is not only a steady
increase in the demand for commodities but has also led to greater utilization. Investment sector is
witnessing high infusions by more and more people connected to the world's trade happenings with
the help of computers. As per statistics, everyday more than $1.5 trillion is now swapped in the
world's currency markets and around one-fifth of products and services are generated per year are
bought and sold.
Buyers of products and services in all nations comprise one huge group who gain from world trade
for reasons encompassing opportunity charge, comparative benefit, economical to purchase than
to produce, trade's guidelines, stable business and alterations in consumption and production.
Compared to others, consumers are likely to profit less from globalization.
Another factor which is often considered as a positive outcome of globalization is the lower inflation.
This is because the market rivalry stops the businesses from increasing prices unless guaranteed by
steady productivity. Technological advancement and productivity expansion are the other benefits
of globalization because since 1970s growing international rivalry has triggered the industries to
improvise increasingly.
Globalization can be described as a process by which the people of the world are unified into a
single society and functioning together. This process is a combination of economic, technological,
sociocultural and political forces. Globalization, as a term, is very often used to refer to economic
globalization, that is integration of national economies into the international economy through
trade, foreign direct investment, capital flows, migration, and spread of technology. The word
globalization is also used, in a doctrinal sense to describe the neoliberal form of economic
globalization.Globalization is also defined as internationalism, however such usage is typically
incorrect as "global" implies "one world" as a single unit, while "international" (between nations)
recognizes that different peoples, cultures, languages, nations, borders, economies, and ecosystems
exist(http://en.wikipedia.org/).
Globalization has two components: the globalization of market and globalization of production....
Some other benefits of globalization as per statistics
Commerce as a percentage of gross world product has increased in 1986 from 15% to nearly
27% in recent years.
The stock of foreign direct investment resources has increased rapidly as a percentage of gross
world product in the past twenty years.
For the purpose of commerce and pleasure, more and more people are crossing national
borders. Globally, on average nations in 1950 witnessed just one overseas visitor for every 100
citizens. By the mid-1980s it increased to six and ever since the number has doubled to 12.
Worldwide telephone traffic has tripled since 1991. The number of mobile subscribers has
elevated from almost zero to 1.8 billion indicating around 30% of the world population. Internet
users will quickly touch 1 billion.
o Promotes foreign trade and liberalisation of economies.
o Increases the living standards of people in several developing countries through capital
investments in developing countries by developed countries.
o Benefits customers as companies outsource to low wage countries. Outsourcing helps the
companies to be competitive by keeping the cost low, with increased productivity.
o Promotes better education and jobs.
o Leads to free flow of information and wide acceptance of foreign products, ideas,
ethics, best practices, and culture.
o Provides better quality of products, customer services, and standardised delivery models
across countries.
o Gives better access to finance for corporate and sovereign borrowers.
o Increases business travel, which in turn leads to a flourishing travel and hospitality industry
across the world.
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o Increases sales as the availability of cutting edge technologies and production
techniques decrease the cost of production.
o Provides several platforms for international dispute resolutions in business, which facilitates
international trade.
Some of the ill-effects of globalisation are as follows:
Leads to exploitation of labour in several cases.
Causes unemployment in the developed countries due to outsourcing.
Leads to the misuse of IPR, copyrights and so on due to the easy availability of technology,
digital communication, travel and so on.
Influences political decisions in foreign countries. The MNCs increasingly use their economical
powers to influence political decisions.
Causes ecological damage as the companies set up polluting production plants in countries
with limited or no regulations on pollution.
Harms the local businesses of a country due to dumping of cheaper foreign goods.
Leads to adverse health issues due to rapid expansion of fast food chains and increased
consumption of junk food.
Causes destruction of ethnicity and culture of several regions worldwide in favour of more
accepted western culture.
In spite of its disadvantages, globalisation has improved our lives in various fields like communication,
transportation, healthcare, and education.
Q.2 What is culture and in the context of international business environment how does it impact
international business decisions?
Ans: Culture is defined as the art and other signs or demonstrations of human customs, civilisation,
and the way of life of a specific society or group. Culture determines every aspect that is from birth
to death and everything in between it. It is the duty of people to respect other cultures, other than
their culture. Research shows that national ‘‘cultures’’ generally characterise the dominant groups’
values and practices in society, and not of the marginalised groups, even though the marginalised
groups represent a majority or a minority in the society.
Culture is very important to understand international business. Culture is the part of environment,
which human has created, it is the total sum of knowledge, arts, beliefs, laws, morals, customs, and
other abilities and habits gained by people as part of society.
Culture is an important factor for practising international business. Culture affects all the business
functions ranging from accounting to finance and from production to service. This shows a close
relation between culture and international business.
The following are the four factors that question assumptions regarding the impact of global business
in culture:
National cultures are not homogeneous and the impact of globalisation on heterogeneous
cultures is not easily predicted.
Culture is not similar to cultural practice.
Globalisation does not characterise a rupture with the past but is a continuation of prior trends.
Globalisation is only one of many processes involved in cultural change.
Cultural differences affect the success or failure of multinational firms in many ways. The company
must modify the product to meet the demand of the customers in a specific location and use
different marketing strategy to advertise their product to the customers. Adaptations must be made
to the product where there is demand or the message must be advertised by the company. The
following are the factors which a company must consider while dealing with international business:
The consumers across the world do not use same products. This is due to varied preferences and
tastes. Before manufacturing any product, the organisation has to be aware of the customer
choice or preferences.
The organisation must manage and motivate people with broad different cultural values and
attitudes. Hence the management style, practices, and systems must be modified.
The organisation must identify candidates and train them to work in other countries as the
cultural and corporate environment differs. The training may include language training,
corporate training, training them on the technology and so on, which help the candidate to
work in a foreign environment.
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The organisation must consider the concept of international business and construct guidelines
that help them to take business decisions, and perform activities as they are different in different
nations. The following are the two main tasks that a company must perform:
o Product differentiation and marketing – As there are differences in consumer tastes and
preferences across nations; product differentiation has become business strategy all over the
world. The kinds of products and services that consumers can afford are determined by the level
of per capita income. For example, in underdeveloped countries, the demand for luxury
products is limited.
o Manage employees – It is said that employees in Japan were normally not satisfied with their
work as compared with employees of North America and European countries; however the
production levels stayed high. To motivate employees in North America, they have come up
with models. These models show that there is a relation between job satisfaction and production.
This study showed the fact that it is tough for Japanese workers to change jobs. While this trend is
changing, the fact that job turnover among Japanese workers is still lower than the American
workers is true. Also, even if a worker can go to another Japanese entity, they know that the
management style and practices will be quite alike to those found in their present firm. Thus,
even if Japanese workers were not satisfied with the specific aspects of their work, they know
that the conditions may not change considerably at another place. As such, discontent might
not impact their level of production.
The following are the three mega trends in world cultures:
The reverse culture influence on modern Western cultures from growing economies, particularly
those with an ancient cultural heritage.
The trend is Asia centric and not European or American centric, because of the growing
economic and political power of China, India, South Korea, and Japan and also the ASEAN.
The increased diversity within cultures and geographies.
The following are the necessary implications in international business:
Avoid self reference criterion such as, one’s own upbringing, values and viewpoints.
Follow a philosophical viewpoint that considers that many perspectives of a single observation or
phenomenon can be true.
Discover and identify global segments and global niche markets, as national markets are diverse
with growing mobility of products, people, capital, and culture.
Grow the total share market by innovating affordable products and services, and making them
accessible so that, they are affordable for even subsistence level consumers rather than fighting
for market share.
Organise global enterprises around global centres of excellence.
Hofstede’s cultural dimensions
According to Dr. Geert Hofstede, ‘Culture is more often a source of conflict than of synergy. Cultural
differences are a trouble and always a disaster.’
Professor Hofstede carried out a detailed study of how values in the workplace are influenced by
culture. He worked as a psychologist in IBM from 1967 to 1973. At that time he gathered and
analysed data from many people from several countries. Professor Hofstede established a model
using the results of the study which identifies four dimensions to differentiate cultures. Later, a fifth
dimension called ‘long-term outlook’ was added.
The following are the five cultural dimensions:
Power Distance Index (PDI) – This focuses on the level of equality or inequality, between
individuals in the nation’s society. A country with high power distance ranking depicts that
inequality of power and wealth has been allowed to grow within the society. These societies
follow caste system that does not allow large upward mobility of its people. A country with low
power distance ranking depicts the society and de-emphasises the differences between its
people’s power and wealth. In these societies equality and opportunity is stressed for everyone.
Individualism – This dimension focuses on the extent to which the society reinforces individual or
collective achievement and interpersonal relationships. A high individualism ranking depicts that
individuality and individual rights are dominant within the society. Individuals in these societies
form a larger number of looser relationships. A low individualism ranking characterises societies of
a more collective nature with close links between individuals. These cultures support extended
families and collectives where everyone takes responsibility for fellow members of their group.
Masculinity – This focuses on the extent to which the society supports or discourages the
traditional masculine work role model of male achievement, power, and control. A country with
high masculinity ranking shows the country experiences high level of gender differentiation. In
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these cultures, men dominate a major part of the society and power structure, with women
being controlled and dominated by men. A country with low masculinity ranking shows the
country, having a low level of differentiation and discrimination between genders. In low
masculinity cultures, women are treated equal to men in all aspects of the society.
Uncertainty Avoidance Index (UAI) – This focuses on the degree of tolerance for uncertainty and
ambiguity within the society that is unstructured situations. A country with high uncertainty
avoidance ranking shows that the country has low tolerance for uncertainty and ambiguity. A
rule-oriented society that incorporates rules, regulations, laws, and controls is created to minimise
the amount of uncertainty. A country with low uncertainty avoidance ranking shows that the
country has less concern about ambiguity and uncertainty and has high tolerance for a variety
of opinions. A society which is less rule-oriented, readily agrees to changes, and takes greater
risks reflects a low uncertainty avoidance ranking.
Long-Term Orientation (LTO) – Describes the range at which a society illustrates a pragmatic
future oriented perspective instead of a conventional historic or short term point of view. The
Asian countries are scoring high on this dimension. These countries have a long term orientation,
believe in many truths, accept change easily, and have thrift for investment. Cultures recording
little on this dimension, trust in absolute truth is conventional and traditional. They have a small
term orientation and a concern for stability. Many western cultures score considerably low on this
dimension.
In India, PDI is the highest Hofstede dimension for culture with a rank of 77, LTO dimension rank is 61,
and masculinity dimension rank is 62.
Every society has its own unique culture. Culture must not be imposed on individuals of different
culture. For example, the Cadbury Kraft Acquisition, 2009 was a landmark international deal, in
which a U.S. based company Kraft acquired the British chocolate giant, Cadbury which were in
complete extremes in terms of culture. Let us discuss the major cultural elements that are related to
business.
Cultural elements that relate business
The most important cultural components of a country which relate business transactions are:
Language.
Religion.
Conflicting attitudes.
Cross cultural management is defined as the development and application of knowledge about
cultures in the practice of international management, when people involved have diverse cultural
identities.
International managers in senior positions do not have direct interaction that is face-to-face with
other culture workforce, but several home based managers handle immigrant groups adjusted into
a workforce that offers domestic markets.
The factors to be considered in cross cultural management are:
Cross cultural management skills
The ability to demonstrate a series of behaviour is called skill. It is functionally linked to achieving a
performance goal.
The most important aspect to qualify as a manager for positions of international responsibility is
communication skills. The managers must adapt to other culture and have the ability to lead its
members.
The managers cannot expect to force members of other culture to fit into their cultural customs,
which is the main assumption of cross cultural skills learning. Any organisation that tries to enforce its
behavioural customs on unwilling workers from another culture faces conflict. The manager has to
possess the skills linked with the following:
Providing inspiration and appraisal systems.
Establishing and applying formal structures.
Identifying the importance of informal structures.
Formulating and applying plans for modification.
Identifying and solving disagreements.
Handling cultural diversity
Cultural diversity in a work group offers opportunities and difficulties. Economy is benefited when the
work groups are managed successfully. The organisation’s capability to draw, save, and inspire
people from diverse cultures can give the organisation spirited advantages in structures of cost,
creativity, problem solving, and adjusting to change.
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Cultural diversity offers key chances for joint work and co-operative action. Group work is a joint
venture where, the production of two or more individuals or groups working in cooperation is larger
than the combined production of their individual work.
Factors controlling group creativity
On complicated problem solving jobs diverse groups do better than identical groups. Diverse groups
require time to solve issues of working together. In diverse groups, over time, the work experience
helps to overcome gender, racial, and organisational and functional discriminations. But the impact
cannot be evaluated and there is always risk in creating a diverse group. A successful group is
profitable with respect to quick results and the creation of concern for the future. Negative
stereotypes are emphasised if it fails.
Factors related with the industry and company culture are also important. Diverse groups do well
when the members:
o Assist to make group decisions.
o Value the exchange of different points of view.
o Respect each other’s skills and share their own.
o Value the chance for cross-cultural learning.
o Tolerate uncertainty and try to triumph over the inefficiencies that occur when members of
diverse cultures work together.
A diverse group is known to be more creative, where the members are tolerant of differences. The
top management level provides its moral and administrative support, and gives time for the group to
overcome the usual process difficulties. They also provide diversity training, and the group members
are rewarded for their commitment.
Ignore diversity
It may be difficult to manage diversity. It is better to ignore, which is an alternative. The
management must:
o Ignore cultural diversity within the employees.
o Down-play the importance of cultural diversity.
This rejection to identify diversity happens when management:
o Fails to have sufficient awareness and skills to identify diversity.
o Identifies diversity but does not have the skill to manage the diversity.
o Recognises the negative consequences of identifying diversity probably cause greater issues
than ignoring it.
o Thinks the likely benefits of identifying and managing diversity do not validate the expected
expenses.
o Identifies that the job provides no chances for drawing advantages from diversity.
Strategies to ignore diversity may be possible when culture groups are given various jobs, and
sharing required resources are independent in the workplace. Groups and group members are
equally incorporated and work together. In such cases, confusion occurs when the diverse value
systems are not identified that are held by different staff groups.
Q3. Cosmos Limited wants to enter international markets. Will country risk analysis help Cosmos
Limited to take correct decisions? Substantiate your answer
Ans: Country risk analysis is the evaluation of possible risks and rewards from business experiences in a
country. It is used to survey countries where the firm is engaged in international business, and avoids
countries with excessive risk. With globalisation, country risk analysis has become essential for the
international creditors and investors
Overview of Country Risk Analysis
Country Risk Analysis (CRA) identifies imbalances that increase the risks in a cross-border investment.
CRA represents the potentially adverse impact of a country’s environment on the multinational
corporation’s cash flows and is the probability of loss due to exposure to the political, economic,
and social upheavals in a foreign country. All business dealings involve risks. An increasing number of
companies involving in external trade indicate huge business opportunities and promising markets.
Since the 1980s, the financial markets are being refined with the introduction of new products.
When business transactions occur across international borders, they bring additional risks compared
to those in domestic transactions. These additional risks are called country risks which include risks
arising from national differences in socio-political institutions, economic structures, policies,
currencies, and geography. The CRA monitors the potential for these risks to decrease the expected
return of a cross-border investment. For example, a multinational enterprise (MNE) that sets up a
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plant in a foreign country faces different risks compared to bank lending to a foreign government.
The MNE must consider the risks from a broader spectrum of country characteristics. Some
categories relevant to a plant investment contain a much higher degree of risk because the MNE
remains exposed to risk for a longer period of time.
Analysts have categorised country risk into following groups:
Economic risk – This type of risk is the important change in the economic structure that produces
a change in the expected return of an investment. Risk arises from the negative changes in
fundamental economic policy goals (fiscal, monetary, international, or wealth distribution or
creation).
Transfer risk – Transfer risk arises from a decision by a foreign government to restrict capital
movements. It is analysed as a function of a country’s ability to earn foreign currency. Therefore,
it implies that effort in earning foreign currency increases the possibility of capital controls.
Exchange risk – This risk occurs due to an unfavourable movement in the exchange rate.
Exchange risk can be defined as a form of risk that arises from the change in price of one
currency against another. Whenever investors or companies have assets or business operations
across national borders, they face currency risk if their positions are not hedged.
Location risk – This type of risk is also referred to as neighborhood risk. It includes effects caused
by problems in a region or in countries with similar characteristics. Location risk includes effects
caused by troubles in a region, in trading partner of a country, or in countries with similar
perceived characteristics.
Sovereign risk – This risk is based on a government’s inability to meet its loan obligations.
Sovereign risk is closely linked to transfer risk in which a government may run out of foreign
exchange due to adverse developments in its balance of payments. It also relates to political risk
in which a government may decide not to honor its commitments for political reasons.
Political risk – This is the risk of loss that is caused due to change in the political structure or in the
politics of country where the investment is made. For example, tax laws, expropriation of assets,
tariffs, or restriction in repatriation of profits, war, corruption and bureaucracy also contribute to
the element of political risk.
Risk assessment requires analysis of many factors, including the decision-making process in the
government, relationships of various groups in a country and the history of the country. Country risk is
due to unpredicted events in a foreign country affecting the value of international assets,
investment projects and their cash flows. The analysis of country risks distinguishes between the ability
to pay and the willingness to pay. It is essential to analyse the sustainable amount of funds a country
can borrow. Country risk is determined by the costs and benefits of a country’s repayment and
default strategies. The ways of evaluating country risks by different firms and financial institutions
differ from each other. The international trade growth and the financial programs development
demand periodical improvement of risk methodology and analysis of country risks.
Purpose of Country Risk Analysis
Risk arises because of uncertainty and uncertainty occurs due to the lack of reliable information.
Country risk is composed of all the uncertainty that defines the risk of country exposure. The
assessment of country risk is used to incorporate country risk in capital budgeting and modify the
discount rate.
CRA regulates the estimated cash flows and explores the main techniques used to measure a
country’s overall riskiness. It is mainly used by MNCs, in order to avoid countries with excessive risk. It
can be used to monitor countries where the MNC is engaged in international business. Analysing the
country risk helps in evaluating the risk for a planned project considered for a foreign country and
assesses gain and loss possibility outcomes of cross-border investment or export strategy.
Country detailed risk refers to the unpredictability of returns on international business transactions in
view of information associated with a particular country. The techniques used by the banks and
other agencies for country risk analysis can be classified as qualitative or quantitative. Many
agencies merge both qualitative and quantitative information into a single rating. A survey
conducted by the US EXIM bank classified the various methods of country risk assessment used by
the banks into four types. They are:
Fully qualitative method – The fully qualitative method involves a detailed analysis of a country. It
includes general discussion of a country’s economic, political, and social conditions and
prediction. Fully qualitative method can be adapted to the unique strengths and problems of
the country undergoing evaluation.
Structured qualitative method – The structured method uses a uniform format with predetermined
scope. In structured qualitative method, it is easier to make comparisons between countries as it
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follows a specific format across countries. This technique was the most popular among the banks
during the late seventies.
Checklist method – The checklist method involves scoring the country based on specific
variables that can be either quantitative, in which the scoring does not need personal judgment
of the country being scored or qualitative, in which the scoring needs subjective determinations.
All items are scaled from the lowest to the highest score. The sum of scores is then used to
determine the country risk.
Delphi technique – The technique involves a set of independent opinions without group
discussion. As applied to country risk analysis, the MNC can assess definite employees who have
the capability to evaluate the risk characteristics of a particular country. The MNC gets responses
from its evaluation and then may determine some opinions about the risk of the country.
Inspection visits – Involves travelling to a country and conducting meeting with government
officials, business executives, and consumers. These meetings clarify any vague opinions the firm
has about the country.
Other quantitative methods – The quantitative models used in statistical studies of country risk
analysis can be classified as discriminant analysis, principal component analysis, logit analysis
and classification and regression tree method
Data sourcing
The basic data is important to analyse a country. The economic, financial and currency risk
components are based on the variables (quantitative and qualitative variables). The variables must
consider the particularities of each country and the needs of the model used. The standard
variables are used to maintain the regular analysis comparable with similar works of other countries.
Therefore, the first step is to make sure that the historical series of official data are reliable, consistent
and comparable. The standard economic variables that are found mainly in the varied approach
adopted by financial institutions and rating agencies, are associated with the country’s real ability to
repay its commitments. The balance of payments (summary account of economic transactions
among a country and the others nations of the world, during a period) and its evolution through the
years means a strong source of data. The exchange rate (currency risk) is another important variable
considered, as it balances the transactions (balances the prices of goods, services, and capital)
between residents and non-residents. The analysis must consider the historical behavior of the
exchange rate and the policy which made clear whether the country follows a rational economics
approach or it uses the exchange rate as a tool to maintain a forced macroeconomic equilibrium.
Apart from the macroeconomic variables which deal with the external sector of the economy, there
are some other relevant variables such as the interest rate, level of investments, public debt and its
service, internal savings, consumption, GDP or GNP, money supply, inflation rate and so on.
The analysis must be accomplished with qualitative variables, which consider social aspects as
population, life expectancy, rate of birthday, rate of unemployment, level of literacy and so on. The
social-political aspects are necessary for all kind of analysis as they describe the whole setting of the
running economy.
Tools
The risk management demands a regular follow up regarding governmental policies, external and
internal environment, outlook provided by rating agencies, and so on. Following are the tools
recommended:
Chain of value – Includes the main countries that sustain trade relationships with the nation,
broken by sectors and products.
Strength and weakness chart – Focus the key aspects that warn the country.
Table of financial markets performance – Follow up the behavior of bonds and stocks already
issued and to be issued.
Table of macroeconomic variables – Provides alert signals when the behavior of any ratio
presents a relevant change.
The content of country risk analysis mainly involves country history, corporate risk, dependency level,
external environment, domestic financial system, ratios for economic risk evaluation and strength
and weakness chart.
Country history
The historical brief helps to identify aspects that interfere in the future behavior of the country,
reducing the ability to payback any external commitment. The main historical data provides a good
understanding of the key factors which draw the behaviour of the society, the government, the
private sector, the legal environment, the economical, political, and the relationships to neighbour
nations and the world as a whole.
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Corporate risk
Both country risk studies and business risk analysis enhances wealth from the available resources, in
terms of capital, natural resources, technology and labour forces. This clarifies that those kind of
analysis procures extensive knowledge from the business approach for companies, including
financial theory.
Dependency level
The next step after the history in brief, is a clear definition about how the country is positioned in the
world in terms of its wide relationships, economic block in which it belongs to, importance of
international trade and so on. All these aspects are significant to identify the dependency level of
the country. The financial dependency to meet the needs of a country is also a strong concern for
the analyst. In this case, the maturity of debts (internal and external) and the available sources of
financing also help to measure the freedom grades of the country.
External environment
The external trade is an important factor to the development of societies. Globalisation has brought
international business to the center of the discussions and the external environment has become
vital for all countries.
Thus, a complete vision on economic trends, the behavior of financial markets, the forecasts for
conflicts among nations, the improvement of the economic blocks, the level of openness of the
world economy, financial crisis and international liquidity is a framework over which the analysis must
start.
Domestic financial system
The banking sector has implemented many actions to avoid losses, after the international crisis. Basel
Committee has defined some strong measures to be followed by the financial houses and Central
Banks are trying to monitor their jurisdictions. Apart from those procedures, recently Asia and Turkey
crisis have shown that the inspection is not enough to keep the reliability of some domestic system.
The international banks had developed many tools to deal with international crisis. When domestic
banks do not have a consistent risk management policies and adequate provisions to theirs credits,
the country risk happens to be the worst. Therefore, the analysis must consider the health of the
domestic financial system, by evaluating information provided by the Central Banks and, from the
principal banks of the country. Accessing Centrals Bank policies and supervising procedures also
help to evaluate the health of the financial system.
Ratios for economic risk evaluation
Cross-border economic risk analysis evaluates the probable macroeconomic ratios among some
variables. They can be separated into two groups such as domestic and external. The figures must
be presented in historic series (at least five years) to provide information about its progress, which
can be real values, percentages, or relations. The mainly used ratios and variables in case of
domestic economy are the following:
· Gross domestic product (GDP) –· GDP per capita –· GDP growth rate –· Unemployment rate –·
Internal savings or GDP –· Investment or GDP –· Gross domestic fixed investment or variation of GDP –
Gini Index –· Growth domestic fixed investment or gross domestic savings –.· Budget deficit or GDP –·
Internal debt or GDP –
The monetary policy is essential as it deals with the price stability. An economy which presents less
instability in its prices of goods and services, provides huge facilities to decision makers based on
their predictions to expected returns of investments and a firm social, economical and political
environment. All these aspects request a systematic approach over price indicators such as the
following:
· Real interest rate –· Percentage increase in the money supply The mainly used ratios and variables
in case of external economy are the following:
· External debt or GDP –· Short term debts and reserves –· Exchange currency rate –· External debt
services and exports –.
Strength and weakness chart
In order to explain the significant aspects provided by the analysis, the strength and weakness chart
can be used to merge each strength and weakness with the related scenario. is a model of
relationships among several variables (quantitative and qualitative) to show their interdependency
and the complexity of analysis.
Q4. How can managers in international companies adjust to the ethical factors influencing
countries? Is it possible to establish international ethical codes? Briefly explain?
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Ans: Ethics can be defined as the evaluation of moral values, principles, and standards of human
conduct and its application in daily life to determine acceptable human behaviour.
Business ethics pertains to the application of ethics to business, and is a matter of concern in the
corporate world. Business ethics is almost similar to the generally accepted norms and principles.
Behaviour that is considered unethical and immoral in society, for example dishonesty, applies to
business as well.
Managers are influenced by three factors affecting ethical values. These factors have unique value
systems that have varying degrees of control over managers.
Religion – Religion is one of the oldest factors affecting ethics. Despite the differences in religious
teachings, religions agree on the fundamental principles and ethics. All major religions preach the
need for high ethical standards, an orderly social system, and stress on social responsibility as
contributing factors to general well-being.
Culture – Culture refers to a set of values and standards that defines acceptable behaviour passed
on to generations. These values and standards are important because the code of conduct of
people reflects on the culture they belong to. Civilisation is the collective experience that people
have passed on through three distinct phases: the hunting and gathering phase, agriculture phase,
and the industrial phase. These phases reflect the changing economic and social arrangements in
human history.
Law – Law refers to the rules of conduct, approved by the legal system of a country or state that
guides human behaviour. Laws change and evolve with emerging and changing issues. Every
organisation is expected to abide the law, but in the pursuit of profit, laws are frequently violated.
The most common breach of law in business is tax evasion, producing inferior quality goods, and
disregard for environmental protection laws.
Ethics is significant in all areas of business and plays an important role in ensuring a successful
business. The role of business ethics is evident from the conception of an idea to the sale of a
product. In an organisation, every division such as sales and marketing, customer service, finance,
and accounting and taxation has to follow certain ethics.
Public image – In order to gain public confidence and respect, organisations must ascertain that
they are honest in their transactions. The services or products of a business affect the lives of
thousands of people. It is important for the top management to impart high ethical standards to
their employees, who develop these services or products.
A company that is ethically and socially responsible has a better public image. People tend to
favour the products and services of such organisations. Investors’ trust is just as important as public
image for any business. A company that practices good ethical creates a positive impression
among its stakeholders.
Management’s credibility with employees – Common goals and values are developed when
employees feel that the management is ethical and genuine. Management’s credibility with
employees and the public are intertwined. Employees feel proud to be a part of an organisation
that is respected by the public. Generous compensations and effective business strategies do not
always guarantee employee loyalty; organisation ethics is equally significant. Thus, companies
benefit from being ethical because they attract and retain good and loyal employees.
Better decision-making – Decisions made by an ethical management are in the best interests of the
organisation, its employees, and the public. Ethical decisions take into account various social,
economic and ethical factors.
Profit maximisation – Companies that emphasise on ethical conduct are successful in the long run,
even though they lose money in the short run. Hence, a business that is inspired by ethics is a
profitable business. Costs of audit and investigation are lower in an ethical company.
Protection of society – In the absence of proper enforcement, organisations are responsible to
practice ethics and ensure mechanisms to prevent unlawful events. Thus, by propagating ethical
values, a business organisation can save government resources and protect the society from
exploitation.
Most countries have similar ethical values, but are practiced differently. This section deals with the
way individuals in different countries approach ethical issues, and their ethically acceptable
behaviour. With the rise in global firms, issues related to ethical values and traditions become more
common. These ethical issues create complications to Multi-National Companies (MNCs) while
dealing with other countries for business. Hence, many companies have formulated well-designed
codes of conduct to help their employees.
Two of the most prominent issues that managers in MNCs operating in foreign countries face are
bribery and corruption and worker compensation.
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Bribery and corruption – Bribery can be defined as the act of offering, accepting, or soliciting
something of value for the purpose of influencing the action of officials in the discharge of their
duties. Corruption is the abuse of public office for personal gain. The issue arises when there are
differences in perception in different countries. For example, in the Middle East, it is perfectly
acceptable to offer an official a gift. In Britain it is considered as an attempt to bribe the official, and
hence, considered unlawful.
Worker compensation – Businesses invest in production facilities abroad because of the availability
of low-cost labour, which enables them to offer goods and services at a lower price than their
competitors. The issue arises when workers are exploited and are underpaid compared to the
workers in the parent country who are paid more for the same job. The disparity arises due to the
differences in the regulatory standards in the two countries.
Earlier, we believed that ethics is a prerogative of individuals, but now this perception has immensely
changed. Many companies use management techniques to encourage ethical behaviour at an
organisational level.
Code of conduct for MNCs
The code of conduct for MNCs refers to a set of rules that guides corporate behaviour. These rules
prescribe the duties and limitations of a manager. The top management must communicate the
code of conduct to all members of the organisation along with their commitment in enforcing the
code.
Some of the ethical requirements for international companies are as follows:
o Respect basic human rights.
o Minimise any negative impact on local economic policies.
o Maintain high standards of local political involvement.
o Transfer technology.
o Protect the environment.
o Protect the consumer.
o Employ labour practices that are not exploitative.
When a manager of an international firm faces an ethical problem, certain models help in solving
these ethical issues
Culture is a major factor which influences marketing decisions and practices in a foreign country. For
example, in the middle-eastern countries the prior approval of the governing authorities should be
taken if a firm plans to advertise a product related to women’s apparel, as showcasing some
aspects of women clothing is considered immodest and immoral.
Q.5 Discuss the international marketing strategies. How is it different from domestic marketing
strategies?
Ans: International marketing refers to marketing of goods and products by companies overseas or
across national borderlines. The techniques used while dealing overseas is an extension of the
techniques used in the home country by the company.
Taking into account the various conditions on which markets vary and depend, appropriate
marketing strategies should be devised and adopted. Like, some countries prevent foreign firms from
entering into its market space through protective legislation. Protectionism on the long run results in
inefficiency of local firms as it is inept towards competition from foreign firms and other
technological advancements. It also increases the living costs and protects inefficient domestic
firms.
To counter this scenario firms must learn how to enter foreign markets and increase their global
competitiveness. Firms that plan to do business in foreign land find the marketplace different from
the domestic one. Market sizes, customer preferences, and marketing practices all vary; therefore
the firms planning to venture abroad must analyse all segments of the market in which they expect
to compete.
The decision of a firm to compete internationally is strategic; it will have an effect on the firm,
including its management and operations locally. The decision of a firm to compete in foreign
markets has many reasons. Some firms go abroad as the result of potential opportunities to exploit
the market and to grow globally. And for some it is a policy driven decision to globalise and to take
advantage by pressurising competitors.
But, the decision to compete abroad is always a strategic down to business decision rather than
simply a reaction. Strategic reasons for global expansion are:
o Diversifying markets that provide opportunistic global market development.
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o Following customers abroad (customer satisfaction).
o Exploiting different economic growth rates.
o Pursuing a global logic or imperative to harvest new markets and profits.
o Pursuing geographic diversification.
o Globalising for defensive reasons.
o Exploiting product life cycle differences (technology).
o Pursuing potential abroad.
Likewise, there can be other reasons like competition at home, tax structures, comparative
advantage, economic trends, demographic conditions, and the stage in the product life cycle. In
order to succeed, a firm should carefully look at their geographic expansion and global marketing
strategy. To a certain extent, a firm makes a decision about its extent of globalisation by taking a
stance that may span from entirely domestic to a global reach where the company devotes its
entire marketing strategy to global competition. In the process of developing an international
marketing strategy, the firm may decide to do business in its home-country (domestic operations)
only or host-country (foreign country) only.
Segmentation
Firms that serve global markets can be segregated into several clusters based on their similarities.
Each such cluster is termed as a segment. Segmentation helps the firms to serve the markets in an
improved way. Markets can be segmented into nine categories, but the most common method of
segmentation is on the basis of individual characteristics, which include the behavioural,
psychographic, and demographic segmentations. The basis of behavioural segmentation is the
general behavioural aspects of the customers. Demographic segmentation considers the factors like
age, culture, income, education and gender. Psychographic segmentation takes into account:
beliefs, values, attitudes, personalities, opinions, lifestyles and so on.
Market positioning
The next step in the marketing process is, the firms should position their product in the global market.
Product positioning is the process of creating a favourable image of the product against the
competitor’s products. In global markets product positioning is categorised as high-tech or high–
touch positioning.
One challenge that firms face is to make a trade-off between adjusting their products to the specific
demands of a country and gaining advantage of standardisation such as the maintenance of a
consistent global brand image and cost savings. This is task is not easy.
International product policy
Some thinkers of the industry tend to draw a distinction between conventional products and
services, stressing on service characteristics such as heterogeneity (variation in standards among
providers, frequently even among different locations of the same firm), inseparability from
consumption, intangibility, and perishability. Typically, products are composed of some service
component like, documentation, a warranty, and distribution. These service components are an
integral part of the product and its positioning.
Firms have a choice in marketing their products across markets. Many a times, firms opt for a
strategy which involves customisation, through which the firm introduces a unique product in each
country, believing that tastes differ so much between countries that it is necessary to create a new
product for each market. On the other hand, standardisation proposes the marketing of one global
product, with the belief that the same product can be sold in different countries without significant
changes. For example, Intel microprocessors are the same irrespective of the country in which they
are sold.
Finally, in most cases firms will go for some kind of adaptation. Here, when moving a product
between markets minor modifications are made to the product. For example, in U.S. fuel is relatively
cheap, therefore cars have larger engines than the cars in Asia and Europe; and then again, much
of the design is identical or similar.
International pricing decisions
Pricing is the process of ascertaining the value for the product or service that will be offered for sale.
In international markets, making pricing decisions is entangled in difficulties as it involves trade
barriers, multiple currencies, additional cost considerations, and longer distribution channels. Before
establishing the prices, the firm must know its target market well because when the firm is clear
about the market it is serving, then it can determine the price appropriately. The pricing policy must
be consistent with the firms overall objectives. Some common pricing objectives are: profit, return on
investment, survival, market share, status quo, and product quality.
The strategies for international pricing can be classified into the following three types:
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· Market penetration· Market holding: · Market skimming:
The factors that influence pricing decisions are inflation, devaluation and revaluation, nature of
product or industry and competitive behaviour, market demand, and transfer pricing.
The approach taken by company towards pricing when operating in international markets are
ethnocentric, polycentric, and geocentric.
Price can be defined by the following equation:
The pricing decision enables us to change the price in many ways, some of them are:
· “Sticker” price changes –. · Change quantity –· Change quality –· Change terms –
Transfer pricing
Transfer pricing is the process of setting a price that will be charged by a subsidiary (unit) of a multi-
unit firm to another unit for goods and services, which are sold between such related units.
Transfer pricing is determined in three ways: market based pricing, transfer at cost and cost-plus
pricing. The Arm’s Length pricing rule is used to establish the price to be charged to the subsidiary.
Many managers consider transfer pricing as non-market based. The reason for transfer pricing may
be internal or external. Internal transfer pricing include motivating managers and monitoring
performance. External factors include taxes, tariffs, and other charges.
Transfer Pricing Manipulation (TPM) is used to overcome these reasons. Governments usually
discourage TPM since it is against transfer pricing, where transfer pricing is the act of pricing
commodities or services. However, in common terminology, transfer pricing generally refers TPM.
International advertising
International advertising is usually associated with using the same brand name all over the world.
However, a firm can use different brand names for historic reasons. The acquisition of local firms by
global players has resulted in a number of local brands. A firm may find it unfavourable to change
those names as these local brands have their own distinctive market.
The purpose of international advertising is to reach and communicate to target audiences in more
than one country. The target audience differ from country to country in terms of the response
towards humour or emotional appeals, perception or interpretation of symbols and stimuli and level
of literacy. Sometimes, globalised firms use the same advertising agencies and centralise the
advertising decisions and budgets. In other cases, local subsidiaries handle their budget, resulting in
greater use of local advertising agencies.
International advertising can be thought of as a communication process that transpires in multiple
cultures that vary in terms of communication styles, values, and consumption patterns. International
advertising is a business activity and not just a communication process. It involves advertisers and
advertising agencies that create ads and buy media in different countries. This industry is growing
worldwide. International advertising is also reckoned as a major force that mirrors both social values,
and propagates certain values worldwide.
International promotion and distribution
Distribution of goods from manufacturer to the end user is an important aspect of business.
Companies have their own ways of distribution. Some companies directly perform the distribution
service by contacting others whereas a few companies take help from other companies who
perform the distribution services. The distribution services include:
The purchase of goods.
The assembly of an attractive assortment of goods.
Holding stocks.
Promoting sale of goods to the customer.
The physical movement of goods.
In international marketing, companies usually take the advantage of other countries for the
distribution of their products. The selection of distribution channel is helpful to gain the competitive
advantage. The distribution channel is also dependent on the way to manage and control the
channel. Selecting the distribution channel is very important for agents and distributors.
Domestic vs. International marketing
Domestic marketing refers to the practice of marketing within a firm’s home country. Whereas
International or foreign marketing is the practice of marketing in a foreign country; the marketing is
for the domestic operations of the firm in that country.
Domestic marketing finds the "how" and "why" a product succeeds or fails within the firm’s home
country and how the marketing activity affects the outcome. Whereas, foreign marketing deals with
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these questions and tries to find answers according to the foreign market conditions and it provides
a micro view of the market at the firm’s level.
In domestic marketing a firm has insight of the marketing practices, culture, customer preferences,
climate and so on of its home country, while it is not totally aware of the policies and the market
conditions of the foreign country.
The stages that have led to achieve global marketing are:
Domestic marketing – Firms manufacture and sell products within the country. Hence, there is no
international phenomenon.
Export marketing – Firms start exporting products to other countries. This is a very basic stage of
global marketing. Here, the products are developed based on the company’s domestic market
although the goods are exported to foreign countries.
International marketing – Now, Firms start to sell products to various countries and the approach
is ‘polycentric’, that is, making different products for different countries.
Multinational marketing – In this stage, the number of countries in which the firm is doing business
gets bigger than that in the earlier stage. And hence, the company identifies the regions to
which the company can deliver same product instead of producing different goods for different
countries. For example, a firm may decide to sell same products in India, Sri lanka and Pakistan,
assuming that the people living in this region have similar choice and at the same time offering
different product for American countries. This approach is termed ‘regiocentric approach’.
Global marketing – Company operating in various countries opts for a common single product in
order to achieve cost efficiencies. This is achieved by analysing the requirements and the choice
of the customers in those countries. This approach is called ‘Geocentric approach’.
The practice of marketing at the international stage does not designate any country as domestic or
foreign. The firm is not considered as the corporate citizen of the world as it has a home base.
The firm must not have a ’single marketing plan’, because there are differences between the target
markets (that is domestic or international markets). There should never be a rigid marketing
campaign. A firm that is successful internationally first obtains success locally.
Few approaches that you can consider for an international marketing are:
Advertise as a foreign product – By doing so, the product will be considered as genuine and
original in some countries.
Joint partnership with a local firm – finding a firm that has already established credibility will
benefit a lot. The product will be considered as a local product by following this marketing
approach.
Licensing – You can sell the rights of your product to a foreign firm. Here the problem is that the
firm may not maintain the quality standard and therefore may hurt the image of the brand.
Culture is a major factor which influences marketing decisions and practices in a foreign country. For
example, in the middle-eastern countries the prior approval of the governing authorities should be
taken if a firm plans to advertise a product related to women’s apparel, as showcasing some
aspects of women clothing is considered immodest and immoral.
Q.6 Explain briefly the international financial management components with examples and
applicability
Ans: The term ‘Financial Management’ refers to the proper maintenance of all the monetary
transactions of the organisation. It also means recording of transactions in a standard manner that
will show the financial position and performance of the organisation. The Financial Management
can be categorised into domestic and international financial management.
The domestic financial management refers to managing financial services within the country.
International financial management refers to managing finance and share between the countries.
The main aim of international finance management is to maximise the organisation’s value that in
turn will increase the impact on the wealth of the stockholders. When the doors of liberalisation
opened, entrepreneurs capitalised the opportunity to step their foot to conduct business in different
parts of the world.
International trade gave way for the growth of international business. For a corporation to be
successful, it is vital to manage the finance and business accounts appropriately. The rise in
significance and complexity of financial administration in a global environment creates a great
challenge for financial managers. The contributions of different financial innovations like currency
derivative, international stock listing, and multicurrency bonds have necessitated the accurate
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management of the flow of international funds through the study of international financial
management.
The International Financial Management (IFM) came to its existence when the countries all over the
world started opening their doors for each other. This phenomenon is also called as liberalisation. But
after the end of the Second World War, the integration in terms of foreign activities has grown
substantially. The firms of all types are now opting to operate their business and deploy their
resources abroad. Furthermore, the differences between the countries have persisted that has given
rise to the prevalence of market imperfections
Components of International Financial Management
Foreign exchange market
The Foreign exchange or the forex markets facilitates the participants to obtain, trade, exchange
and speculate foreign currency. The foreign exchange market consists of banks, central banks,
commercial companies, hedge funds, investment management firms and retail foreign exchange
brokers and investors. It is considered to be the leading financial market in the world. It is vital to
realise that the foreign exchange is not a single exchange, but is created from a global network of
computers that connects the participants from all over the world.
The foreign exchange market is immense in size and survives to serve a number of functions ranging
from the funding of cross-border investment, loans, trade in goods, trade in services and currency
speculation. The participant in a foreign exchange market will normally ask for a price.
The trading in the foreign exchange market may take place in the following forms:
Outright cash or ready – foreign exchange currency deals that take place on the date of the
deal.
Next day – foreign exchange currency deals that take place on the next working day.
Swap – Simultaneous sale and purchase of identical amounts of currency for different maturities.
“Spot” and “Forward” contracts – A Spot contract is a binding obligation to buy or sell a definite
amount of foreign currency at the existing or spot market rate. A forward contract is a binding
obligation to buy or sell a definite amount of foreign currency at the pre-agreed rate of
exchange, on or before a certain date.
The advantage of spot dealing has resulted in a simplest way to deal with all foreign currency
requirements. It carries the greatest risk of exchange rate fluctuations due to lack of certainty of the
rate until the deal is carried out. The spot rate that is intended to receive will be set by current
market conditions, the demand and supply of currency being traded and the amount to be dealt.
In general, a better spot rate can be received if the amount of dealing is high. The spot deal will
come to an end in two working days after the deal is struck.
A forward market needs a more complex calculation. A forward rate is based on the existing spot
rate plus a premium or discounts which are determined by the interest rate connecting the two
currencies that are involved. For example, the interest rates of UK are higher than that of US and
therefore a modification is made to the spot rate to reflect the financial effect of this differential over
the period of the forward contract. The duration will be up to two years for a forward contract. A
variation in foreign exchange markets can be affected to any company whether or not they are
directly involved in the international trade or not. This is often referred to as ‘Economic’ foreign
exchange and most difficult to protect a business.
The three ways of managing risks are as follows:
Choosing to manage risk by dealing with the spot market whenever the need of cash flow rises.
This will result in a high risk and speculative strategy since one will not know the rate at which a
transaction is dealt until the day and time it occurs. Managing the business becomes difficult if it
depends on the selling or buying the currency in the spot market.
The decision must be made to book a foreign exchange contract with the bank whenever the
foreign exchange risk is likely to occur. This will help to fix the exchange rate immediately and will
give a clear idea of knowing the exact cost of foreign currency and the amount to be received
at the time of settlement whenever this due occurs.
A currency option will prevent unfavourable exchange rate movements in the similar way as a
forward contract does. It will permit gains if the markets move as per the expectations. For this
base, a currency option is often demonstrated as a forward contract that can be left if it is not
followed. Often banks provide currency options which will ensure protection and flexibility, but
the likely problem to arise is the involvement of premium of particular kind. The premium involved
might be a cash amount or it could also influence into the charge of the transaction.
Foreign currency derivatives
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Currency derivative is defined as a financial contract in order to swap two currencies at a
predestined rate. It can also be termed as the agreement where the value can be determined from
the rate of exchange of two currencies at the spot. Hence, the spot market exposures can be
enclosed with the currency derivatives. The main advantage from derivative hedging is the basket
of currency available.
Figure 1 describes the examples of currency derivatives. The derivatives can be hedged with other
derivatives. In the foreign exchange market, currency derivatives like the currency features,
currency options and currency swaps are usually traded. The agreement undertaken to exchange
cash flow streams in one currency for cash flow streams in another currency in future is provided by
currency swaps. These will help to increase the funds of foreign currency from the cheapest sources.
Figure 1: Example for Foreign Currency Derivatives
Some of the risks associated with currency derivatives are:
Credit risk takes place, arising from the parties involved in a contract.
Market risk occurs due to adverse moves in the overall market.
Liquidity risks occur due to the requirement of available counterparties to take the other side of
the trade.
Settlement risks similar to the credit risks occur when the parties involved in the contract fail to
provide the currency at the agreed time.
Operational risks are one of the biggest risks that occur in trading derivatives due to human error.
Legal risks pertain to the counterparties of currency swaps that go into receivership while the
swap is taking place.
International monetary systems
The international monetary systems represent the set of rules that are agreed internationally along
with its conventions. It also consists of set of rules that govern international scenario, supporting
institutions which will facilitate the worldwide trade, the investment across cross-borders and the
reallocation of capital between the states.
International monetary systems provide the mode of payment acceptable between buyers and
sellers of different nationality, with addition to deferred payment. The global balance can be
corrected by providing sufficient liquidity for the variations occurring in trade. Thereby it can be
operated successfully.
The gold and gold bullion standards
The gold standard was the first modern international system. It was operating during the late 19th
and early 20th centuries, the standard provided for the free circulation between nations of gold
coins of standard specification. The gold happened to be the only standard of value under the
system. The advantages of this system depend in its stabilising influence. Any nation which exports
more than its import would receive gold in payment of the balance. This in turn has resulted in the
lowered value of domestic currency. The higher prices lead to the decreased demands for exports.
The sudden increase in the supply of gold may be due to the discovery of rich deposit, which in turn
will result in the increase of price abruptly.
This standard was substituted by the gold bullion standard during the 1920s; thereby the nations no
longer minted gold coins. Instead, reversed their currencies with gold bullion and determined to buy
and sell the bullion at a fixed cost. This system was also discarded in the 1930s.
The gold-exchange system
Trading was conducted internationally with respect to the gold-exchange standard following World
War II. In this system, the value of the currency is fixed by the nations with respect to some foreign
MBA 4th Sem Assignment International Business Management – MB0053 – Set 1
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currency but not with respect to gold. Most of the nations fixed their currency to the US dollar funds
in the United States. With a view to maintain a stable exchange rate at the global level, the
International Monetary Fund (IMF) was created at the ‘Bretton Woods international Conference’
held in 1944. The drain on the US gold reserves continued up to the 1970s. Later in 1971, the gold
convertibility was abandoned by the United States leaving the world without a single international
monetary system.
Floating exchange rates and recent development
After the abundance of the gold convertibility by the US, the IMF in 1976 decided to be in
agreement on the float exchange rates. The gold standard was suspended and the values of
different currencies were determined in the market. The ‘Japanese yen’ and the ‘German
Deutschmark’ strengthened and turned out to be increasingly important in international financial
market, at the same time the US dollar diminished its significance. The Euro was set up in financial
market in 1999 as a replacement for the currencies. Hence, it became the second most commonly
used currency after the dollar in the international market. Many large companies opt to use euro
rather than the dollar in bond trading with a goal to receive better exchange rates. Very recently
the some of the members of Organisation of Petroleum Exporting Countries (OPEC) such as Saudi
Arabia, Iraq have opted to trade petroleum in Euro than in Dollar.
International financial markets
International foreign markets provide links connecting the financial markets of each country and
independent markets external to the authority of any one country. The heart of the international
financial market is being governed by the market of currency where the foreign currency is
denominated by the international trade and investment. Hence the purchase of goods and services
is preceded by the purchase of currency.
The purpose of the foreign currency markets, international money markets, international capital
markets and international securities markets are as follows:
The foreign currency markets – The foreign currency market is an international market that is
familiar in structure. This means that there exists no central place where the trading can take
place. The ’market’ is actually the telecommunications like among financial institutions around
the globe and opens for business at any time. The greater part of the worlds that deal in foreign
currencies is still taking position in the cities where international financial activity is centred.
International money markets – A money market can be conventionally defined as a market for
accounts, deposits or deposits that include maturities of one year or less. This is also termed as
the Euro currency markets which constitute an enormous financial market that is beyond the
influence and supervision of world financial and government authorities. The Euro currency
market is a money market for depositing and borrowing money located outside the country
where that money is officially permitted tender. Also, Euro currencies are bank deposits and
loans existing outside any particular country.
International capital markets – The international capital provides links among the capital markets
of individual countries. It also comprises a separate market of their own, the capital market that
flows in to the Euro markets. The firms enjoy the freedom to raise capital, debit, fixed or floating
interest rates and maturities varying from one month to thirty years in an international capital
markets.
International security markets – The banks have experienced the greatest growth in the past
decade because of the continuity in providing large portion of the international financial needs
of the government and business. The private placements, bonds and equities are included in the
international security market.
The following are the reasons given for the enormous growth in the trading of foreign currency:
Deregulation of international capital flows – Without the major government restrictions, it is
extremely simple to move the currencies and capital around the globe. The majority of the
deregulation that has differentiated government policy over the past 10 to 15 years.
Gain in technology and transaction cost efficiency – The advancements in technology is not only
taking place in the distribution of information, in addition to the performance of exchange or
trading. This has resulted greatly to the capacity of individuals on these markets to accomplish
instantaneous arbitrage.
Market upwings – The financial markets have become increasingly unstable over recent years.
There are faster swings in the stock values and interest rates, adding to the enthusiasm for
moving further capital at faster rates.