INTERNATIONAL FINANCE – ASSESMENT 1

1. Discuss the difference between international finance and domestic finance.

a) Exposure To Foreign Exchange

MNE’s face foreign exchange due to their subsidiaries, as well as import/export

and foreign competitions. Domestic have no subsidiaries in their business due to

local.

b) Culture, History & Institution

In culture view, each foreign country is unique and not always understood by

MNE management, this is way MNE will face language and culture barriers.

Domestic financial management have a strong base case of their own country.

c) Corporate Governance

Foreign countries’ regulation and institutional practice are also uniquely different,

especially legal and tax impacts to MNE’s in foreign country. International

finance manager need to look at the taxation structure to find out whether the

business which is feasible in his home country workable in the foreign country or

not.

d) Political Risk

MNEs face political risks because of their foreign subsidiaries and high profile,

while domestic negligible political risks.

e) Modification of Domestic Finance Theories

MNEs must modify finance theories like capital budgeting and cost of capital

because of the foreign complexities. Domestic will stick to traditional financial

theory.

f) Modification of Domestic Financial Instrument

MNEs utilize modified financial instruments such as options, future, swaps, and

letters of credit. Domestic limited use of financial instruments and derivatives

because of fewer foreign exchange and political risks.

2. Explain the most traded currencies in the world and the reason of their popularity

a) The United States Dollar.

First and foremost is the US Dollar, which is easily the most traded currency on the

planet and can be attributed to the long term government stability and the economic

dynamism of the United States. This is because the USD acts as the unofficial

global reserve currency, held by nearly every central bank and institutional investment

entity in the world. The dollar is an important factor in the foreign exchange rate

market for other currencies, where it may act as a benchmark or target rate for

countries that choose to fix or peg their currencies to the USD's value. For instance, as

of 2011, China has its currency, the renminbi, still pegged to the dollar, much to the

disagreement of many economists and central bankers.

b) The Euro

The Euro is one of the youngest and it is considered as the official currency from

Finland to Portugal and from Slovakia to Slovenia. As well, the Euro is the world's

second largest reserve currency. With the euro being a widely used and trusted

currency, it is very prevalent in the forex market, adds liquidity to any currency pair it

trades within. The Euro is commonly traded by speculators as a play on the general

health of the eurozone and it member nations

c) The Japanese Yen

Currently, the Japanese yen has gained so much ground because its value has tripled.

Many use the yen to gauge the overall health of the Pan Pacific region as well, taking

economies such as South Korea, Singapore and Thailand into consideration,as those

currencies are traded far less in the global forex markets. With Japan having basicallu

0% interest rate policy for much of the 90s and 20s.

d) The British Pound

The pound has somewhat lost its glory. A few decades back, it was the second most

widely used currency, but with the decline of the British Empire and the rise of the

euro, the pound took the backseat. Today, only six % of all the foreign exchange

transactions use the pound for trading. If you are wondering why the pound suddenly

fell to fourth place, the best answer will be due to the fact that it is in a relative

vacuum. The government of the United Kingdom fixed its price relative to the dollar

and this is not good because it no longer reflects the currency’s actual importance.

e) The Australian Dollar

This currency was created in 1966 as a replacement to the Australian pound, which is

now obsolete. Ever since then, it became one of the most popular reserve currencies

that is traded throughout Oceania and the Asia-Pacific region Foreign exchange in the

21st century moves towards diversity. Investors are looking into the currency’s

stability and volatility. Also, the economy’s reputation and security as a nation also

matters in the process of choosing.

3. Discuss the methods to improve local currency stability.

a) Appropriate Choice of Exchange Rate Regime

Malaysia should adopt an exchange-rate regime that provides flexibility but reduces

volatility. It may be necessary for the ringgit to move within an exchange-rate band

against a trade-weighted basket of currencies that is reviewed regularly, at least every

three years. By establish an early warning system to be monitored among key

government agencies that identify negative developments within the financial and

currency markets well ahead of time. Also work towards getting an international

agreement for more transparency and greater disclosure in the operations of

investment funds, such as pension funds, currency funds, and hedge funds. Strengthen

international surveillance for an orderly international monetary system that is based

on sound banking and financial system.

b) Reduce an Over-Dependence on the US Dollar

Although 18 per cent of Malaysia is overall trade is with the United States, about 70

per cent of its trade settlements are conducted in the US dollar, which has appreciated

against most currencies. Only about 15 per cent of Malaysia is total trade settlements

are in ringgit and 6.5 per cent in yen. There is a need to reduce an over-dependence on

the US dollar in Malaysia is trade with other countries and build up reserves of

different foreign currencies. Therefore encourage quotations of Malaysia’s exports in

the currency of the country concerned. An expert group should examine the details on

the mechanics and operation of bilateral and multilateral payment arrangements for

trade among ASEAN countries.

c) Higher Interest Rates

Higher interest rate would attract some ‘hot money flow’. Hot money flows occurs

when banks and financial institutions move money to other countries to take

advantage of a better rate of return on saving. Given interest rate are close to zero in

the US, higher interest rate in developing countries give a significant incentive to

move money and saving there.

d) Reduce Inflation

If inflation is relatively lower than competitors, then the countries goods will become

more attraction and demand will rise. Lower inflation tends to increase the value of

the currency in the long term. To reduce inflation, the government can pursue tighter

fiscal and monetary policy.