INTERNATIONAL FINANCE

IAME International Academy of Management &

Entrepreneurship

Shashank BP

About me: Shashank BP

BE (Mechanical) Delhi College of Engineering (now Delhi
Technological University), 1989-93
Masters in Business Management, Asian Institute of
Management, Manila, Philippines, 1995-97
Worked for Life Insurance and Mutual Fund MNC Sun Life
of Canada, Asia Pacific Regional Headquarters, Manila,
Philippines, as Business Planner.
Worked for TVS Electronics Limited, as Business Planner.
18 years experience as a freelance Business Planning.
Have also taught management to a number of students.
Email ID: [email protected]
Will reply to every subject related question by email..
2

Your Introduction
Please take a single white paper and fill out these details in the
format shown:
Name

Email ID

PGDM, MBA or
MIB?

Bachelors Degree
(BE / B.Com. etc.)

International Finance Syllabus

Module 1
International Finance Issues and Dimensions
The Internationalization process
Structure of foreign exchange market
International financial flows and the balance of payments
framework
International monetary system IMF
The nature of global capital flows FDI, FII, Private equity
and hedge funds

International Finance Syllabus

Module 2
Foreign exchange: Empirical evidence on exchange rate
determination
Exchange rate determination: Structural models of
exchange rate determination
Interest Rate Parity (IRP) and Purchasing Power Parity
(PPP)
Exchange rate forecasting
Transfer pricing
Netting

International Finance Syllabus

Module 3
The foreign exchange market: Structure, types of
transactions and arbitrage
Foreign exchange derivatives markets
Exchange rate regimes foreign exchange market in India
Module 4
Measurement of exposure and risk Financial accounting
and foreign exchange
Classification, transaction, translation and operating
exposures
Management of exposures
6

International Finance Syllabus

Module 4 (Contd.)
Managing accounting exposure
Measuring economic exposure
Managing economic exposure
Hedging, forwards, currency futures, options, swaps and
hedging with money market.
Management of interest rate exposure: Forward Rate
Agreements (FRA) interest rate caps and floors.
Financial swaps types motivation
Application of swaps
GDR, ADR
7

International Finance Syllabus

Module 5
International capital budgeting
International portfolio investment
Capital budgeting for the MNC
Cost of capital for foreign investments
Managing political risk

International Finance Syllabus

Module 6
Multinational working capital management short term
financing
Financing foreign trade
Current asset management for multinational
Multinational financial system

Question Paper review

Review of question papers of PGDM & MBA (minimum 3
years), as practice. [MIB 2008, 2009, 2010, 2013 available,
AIMA PGDM papers also available, MBA not available]
Learning the art of answering questions acceptable to
examiners
9

International Finance References

Adrian Buckley Multinational Finance (online version
available)
Suk Kim and Seung Kim Global Corporate Finance: Text
and Cases (online version available)
Alan C. Shapiro Multinational Financial Management
(IAME Library)
PG Apte International Financial Management (IAME
Library)
Jeff Madura International Financial Management (online
version available)
AIMA study material (IAME Library)

10

International Finance
International Finance (IF) is a branch of Economics /
Financial Management.
Deals with the dynamics of Foreign Exchange Rates, Foreign
Investment, International Trade etc.
Is a vast field.
Most crucial for MNCs.
Companies need to insulate from adverse Foreign
Exchange, Inflation and Interest rates.
Companies also need to benefit from large markets,
economies of scale and unprecedented global activity.
Risk management includes strategies to insulate from
Foreign Exchange risk, political risk and market variations.
11

Role of Finance Manager in MNCs

Understanding and forecasting financial environment.
Capital budgeting and funding strategies.
Exchange risk management.
Meeting tax authorities requirements in various countries.
Understanding legal aspects of financial management
across countries.
Understanding challenges/differences between domestic
finance management and international finance management.

12

Keywords so far..
Capital Budgeting Capital budgeting, or investment
appraisal, is the planning process used to determine whether
an organizations long term investments such as new
machinery, replacement machinery, new plants, new
products, and research development projects are worth the
funding of cash through the firms capital structure (debt,
equity or retained earnings). It is the process of allocating
resources for major capital, or investment, expenditures. One
of the primary goals of capital budgeting investments is to
increase the value of the firm to the shareholders.

13

Domestic finance vs. International finance

Exposure to Foreign Exchange: Currency exposure impacts
almost all the areas of an international business starting from
purchase from suppliers, selling to customers, investing in
plant and machinery, fund raising etc.
Macro Business Environment: All trade policies are different in
different countries. Financial manager has to critically analyze
the policies to understand the feasibility and profitability of
business propositions. One country may have business
friendly policies and another may not.
Legal and Tax Environment: Tax impacts directly to the net
profits. International finance manager has to look at the
taxation structure to find out whether the business that is
feasible in his home country is workable in the foreign country
or not.
Contd..

14

Domestic finance vs. International finance

Different group of Stakeholders: Money apart, keeping all
stakeholders (suppliers, customers, lenders, shareholders,
interest groups) happy is important especially in a new place
with a different culture, values, language and belief system.
Foreign Exchange Derivatives: Since it is inevitable to be
exposed to the risk of foreign exchange in a multinational
business, knowledge of forwards, futures, options and swaps
is required. A financial manager has to be strong enough to
calculate the cost impact of hedging the risk with the help of
different derivative instruments while taking any financial
decisions.

Contd..

15

Domestic finance vs. International finance

Different Standards of Reporting: If the business has presence
in, say, US and India, the books of accounts need to be
maintained in US GAAP and IGAAP. It is not surprising to know
that the booking of assets has a different treatment in one
country compared to another. Managing the reporting task is
another big difference. The financial manager or his team
needs to be familiar with accounting standards of different
countries.
Capital Management: In an MNC, the financial managers have
ample ways to raise capital. More number of ways creates
more challenge with respect to selection of right source of
capital to ensure the lowest possible cost of capital.

16

Birds Eye View of Global Trade Growth

World exports grew from US$334 Billion in 1971 to
US$16000 Billion in 2008.
Of this, developing countries exports grew from paltry
US$19 Billion in 1971 to US$2500 Billion in 2008.
GDP growth in developing countries was in the range of 6%
to 8% from year 2000.
Capital flow growth was also on the same lines.
FDI in India grew to over US$35000 million by 2008-09 from
US$4000 million in 2000-01.
Indian companies like Tata Steel, Dr.Reddys Labs, Videocon
and Suzlon made foreign acquisitions of total deal value over
US$25000 million.
17

Birds Eye View of Global Trade Growth

Last 25 years, veritable revolution has taken place in money
and capital markets.
Bewildering menu of funding techniques, investing vehicles,
risk management products are there in the market.
Accounting as well as Treasury functions in corporates are
facing new challenges.
Responsibilities of Finance Managers taking a new turn
challenging, demanding, and exciting.
New world financial structures are emerging, due to
deregulation and innovation.

18

Case 1
The globalization of financial markets brought about by recent
technological changes, financial market liberalization and the
removal of capital controls has impressed upon all MNCs with
international cash flows the necessity to manage foreign
exchange exposure that a floating exchange system creates.
Today MNCs are trying to develop techniques and strategies
for effective foreign exchange exposure management. The
foreign exchange strategy adopted is critical to an MNC in the
present day environment due to the high variability in the
exchange rates and needs to evolve with the changing
structure of the company. Further, in view of the fact that
firms are now more frequently entering into financial and
commercial contracts denominated in foreign currencies,
judicious measurement and management of transaction
exposure has become critical to the success of MNCs.
19

Case 1 (Contd.)
Q1) Outline the numerous challenges that a MNC faces when
trying to manage exposure in various currencies.
Q2) Do you think currency correlation and variability are
related to the political risk which a currency faces? Can you
give examples to illustrate your answer?

20

Answer to Case 1
Movement of men and capital is very high in the globalized
world.
Exchange rate fluctuations, Trade balance, Balance of
Payments, government rules, regulations and government
policies affect businesses.
There has to be a close watch on the socio-political
developments in countries where MNCs are investing.
What happens in Greece is affecting capital markets and
currencies all over.
Integrated, inter-dependent financial environment exists all
over.
Enron USA had to windup its Indian expansion plans due to
political developments in Maharashtra.
21

Enrons India debacle

Enron tried to bully Maharashtra government in India to get into
power development.
Enrons investment was $3 billion, in a 10-year liquefied natural gas
power plant development project, the largest development project
and the single largest direct foreign investment in Indias history.
Begun in 1992, the Dabhol power plant near Indias financial capital
of Bombay in Maharashtra state was to have gone online by 1997. It
was supposed to supply energy-hungry India with more than 2,000
megawatts of electricity, about one-fifth the new energy needed by
India each year.
But endless disputes over prices and terms of the deal turned the
venture into a symbol of what can go wrong in large-scale
development projects when cultures collide.
In June 2001, with the project about 90 percent complete,
development was again put on hold amid disagreements over the
price of energy. Work has not resumed since.
22

Keywords in Case 1
Floating exchange rate A country's exchange rate regime
where its currency is set by the foreign-exchange market
through supply and demand for that particular currency
relative to other currencies. Thus, floating exchange rates
change freely and are determined by trading in the forex
market. This is in contrast to a "fixed exchange rate" regime.
Exchange exposure Foreign exchange exposure is the risk
associated with activities that involve a global firm in
currencies other than its home currency. Essentially, it is the
risk that a foreign currency may move in a direction which is
financially detrimental to the global firm.
(Contd..)
23

Keywords in Case 1
Transaction exposure - The risk, faced by companies involved
in international trade, that currency exchange rates will
change after the companies have already entered into
financial obligations. Such exposure to fluctuating exchange
rates can lead to major losses for firms.
Balance of payments - The balance of payments (BOP) of a
country is the record of all economic transactions between
the residents of a country and the rest of the world in a
particular period (over a quarter of a year or more commonly
over a year). These transactions are made by individuals, firms
and government bodies.
(Contd..)
24

Keywords in Case 1
Trade Balance Balance of Trade is simply the difference
between the value of exports and value of imports. Thus,
the Balance of Trade denotes the differences of imports and
exports of a merchandise of a country during the course of
year.

25

Evolution of World Monetary Systems

1.
2.
3.
4.
5.

Gold Standard till 1913

Interwar period till 1944
Bretton Woods system till 1972
European Monetary system
Flexible Exchange Rate system (1973 onwards)

26

Evolution of World Monetary Systems

1. Gold Standard 1876-1913: Each country is required to link
currency value to Gold. For example, US$20.67 per ounce
of gold and UK4.2474 per ounce of gold. This could not
run too long because countries could not always ensure
flow of gold as gold is a scarce commodity.
2. The Interwar Years 1914-1944 (including first and second
world wars): During this period, stability of exchange
rates of all currencies was disturbed and the system
totally crumbled.
3. The Bretton Woods System 1945-1972:
Negotiators felt the need for a monetary system that
would recognize that exchange rates were both a
national and international concern.
27

Evolution of World Monetary Systems

3. The Bretton Woods System 1945-1972 (Continued):
Established a dollar based International Monetary
System and created IMF and IBRD (World Bank).
Decided to facilitate expansion of new world trade
and use US dollar as a standard of value.
Fixed and adjustable rates formula was adapted.
Adjustable rates of par value only on IMFs approval.
All nations maintain their foreign exchange reserves
principally in the form of US dollars or British Pound.
The Bretton Woods system also failed as it suffered from a
number of inherent structural problems like (a) imbalance in
the roles and responsibilities of the surplus and deficit
nations, and
28

Evolution of World Monetary Systems

(b) rigid approach of the IMF to the Balance of Payments
equilibrium situation countries with adverse Balance of
Payments position have to exercise tight control over their
internal economic policies, inflation and employment issues.
By Aug Dec 1971, most of the major currencies were
allowed to fluctuate.
Most leading countries were unwilling to subordinate
domestic policies to maintenance of the exchange rate.
Most country governments began to intervene and the float
was no longer clean. This is called dirty float.

29

European Monetary System (EMS)

European countries started EMS.
EMS is essentially the IMFs adjustable peg system.
EMS has a wider band for adjustment within the currencies
of Euro nations and for nations outside Euro as well.
EMS also had Smithsonian Agreement signed in December
1971 and was also known as snake, which is a narrower
band of float within EU countries currencies. This is to
maintain monetary stability within EU countries.
The following systems are working even today:
ERM (Exchange rate mechanism),
ECU (European currency unit),
EMCF (European monetary cooperation fund).
30

Flexible Exchange Rate System

From 1973 onwards till now..
Currency Pegged to
US Dollar
Antigua
and
Barbuda
Argentina
The Bahamas
Barbados
Belize
Djibouti
Dominica
Grenada
Iraq
Lithuania
Malaysia
Micronesia
Nigeria
Oman
Palau
Panama
St.Kitts
Nevis
St.Lucia
St.Vincent
Grenadines
Syria

French Franc
Benin
Burkina Faso
Cameroon
C.Africa
Chad
Comoros
Congo
Cote d'Ivoire
Equatorial Guinea
Gabon
Guinea-Bissau
Mali
Senegal
Togo

Special Drawing
Other Currency
Rights (SDR) basket
Bhutan (Indian Rupee)
Jordan
Bosnia and Herzegovina (Deutsche Mark)
Lavita
Brunei Darussalam (Singapore Dollar)
Libya
Bulgaria (Deutsche Mark)
Myanmar
Cape Verde (Port Escudo)
Estonia (Deutsche Mark)
Kiribati (Australian Dollar)
Lesotho (South African Rand)
Namibia (South African Rand)
Nepal (Indian Rupee)
San Marino (Italian Lira)
Swaziland (South African Rand)

Other
composite
Bangladesh
Botswana
Burundi
Cyprus
Fiji
Iceland
Kuwait
Malta
Morocco
Samoa
Seychelles
Tonga
Vanuatu

31

Flexible Exchange Rate System

Single currency

Limited Flexibility
Cooperative
arrangments

More Effective
Other Managed Listing

Independent Floating

Bahrain

Austria

Algeria, Angola

Malawi, Mauritania

Afghanistan, Albania

New Zealand

Qatar

Belgium

Azerbaijan, Belarus

Mauritius, Nicaragua

Armenia, Australia

Papua New Guinea

Saudi Arabia

Denmark

Bolivia, Brazil

Nigeria, Norway

Canada, Congo

Peru, Philippines

UAE

Finland

Cambodia, Chile

Pakistan, Paraguay

Entrea, Gambia

Rwanda, Sao Tome

France

China, Colombia

Piland, Romania

Ghana, Gautemala

Principe, Sierra Leone

Germany

Costa Rica, Croatia

Rissoa, Singapore

Guinea, Guyana

Somalia, South Africa

Greece

Czech Republic

Slovak Rep, Slovenia

Haiti, India

Sweden, Switzerland

Ireland

Dominican Rep

Solomon Islands

Indonesia, Jamaica

Tamzamoa, Thailand

Italy

Ecuador, Egypt

Sri Lanka, Sudan

Japan, Korea

Trinidad & Tobago

Luxembourg

El Salvador, Ethopia

Suriname, Tajikistan

Lebanon, Liberia

Uganda, United Kingdom

Netherlands

Georgia, Honduras

Rep. Tunisa, Turkey

Madagascar, Mexico

United States

Portugal

Hungary, Iran

Turkmenistan

Moldava, Mongolia

Yemen, Zambia

Spain

Israel, Kazaksthan

Ukraine, Uruguay

Mozambique

Zimababwe

Kenya, Kyrgyu Rep

Uzbekistan, Venezuela

Lao PDR, Macedonia

Vietnam

Tables show how many currencies are pegged to another.

India is following a limited flexible exchange rate system
partially backed by gold reserves and pegged currencies.

32

The Internationalization Process

Some start as International firms.
Some successful firms enter global scene after domestic
success.
International marketing starts with segmentation
Geographical, Behavioral, Benefit and then choose where
to enter and when to enter.
Entry modes are through various ways Product exports,
service exports, turnkey projects, licensing, franchising, joint
venturing.
Each has its own advantages and disadvantages.
Greenfield venture (acquisitions) and strategic alliances are
other ways to enter a foreign country.
33

Keywords in Internationalization process

Geographical segmentation: We can geographically segment a
market by area, such as cities, counties, regions, countries, and
international regions. We can also break a market down into
rural, suburban and urban areas. And, you can break down a
market by size and climate.
Behavioural segmentation: Behavioural segmentation divides
a population based on their behaviour, the way the population
respond to, use or know a product. E.g. Hotels doing mass
marketing by clubbing Christmas and New Year together.
Benefit segmentation: Benefit segmentation is dividing the
market based upon the perceived value, benefit or advantage
consumers perceive that they receive from a product or service.
We can segment the market based upon quality, performance,
customer service, special features or other benefits.
34

Keywords in Internationalization process

Acquisition: A corporate action in which a company buys most, if
not all, of the target companys ownership stakes in order to
assume control of the target firm. Acquisitions are often made as
part of a companys growth strategy whereby it is more beneficial
to take over an existing firms operations and niche compared to
expanding on its own. Acquisitions are often paid in cash, the
acquiring companys stock or a combination of both.
Strategic Alliance: An arrangement between two companies that
have decided to share resources to undertake a specific, mutually
beneficial project. A strategic alliance is less involved and less
permanent than a joint venture, in which two companies typically
pool resources to create a separate business entity. In a strategic
alliance, each company maintains its autonomy while gaining a
new opportunity. A strategic alliance could help a company
develop a more effective process, expand into a new market or
develop an advantage over a competitor.
35

The Internationalization Process

Entry Mode
Exporting

Advantages
Can understand location.

Disadvantages
High transport costs, trade barriers,
problems with local marketing agents.
Turnkey Contracts
Can earn returns using technology Efficient competitors get created, lack
skills.
of long term market penetration.
Licensing
Low development costs and risks. No control over technology, cannot
understand location, cannot experience
economies, cannot do global strategy
coordination.
Fanchising
Low development costs and risks.
No control over quality, cannot do
global strategy coordination.
Joint Ventures
Access to local partners'
No control over technology, cannot
knowledge, sharing of
understand location, cannot experience
development costs and risks,
economies, cannot do global strategy
politically acceptable.
coordination.
Wholly Owned Subsidiaries Protection of technology, can do
High cost, high risk.
global strategy coordination, can
understand location, can
experience economies.

36

Case 2
We want to sell carpets to the foreign markets. This can only
be done through exports. When profits from exports
increase, we go in for international marketing, which leads to
international trade and international business. How does it
happen? This happens only when our company becomes
international, multinational and transnational.
The carpet industry, at present, is passing through the
international marketing stage. The carpets that are exported
follow the concept of ethnocentricity. In order to make the
carpet industry a MNC, the export of carpets has to increase
to more than $100 million turnover per annum. This can only
happen if this industry is properly organized and given more
incentives by the government, it being a labor intensive
industry.
37

Case 2 (Contd.)
The question of becoming transnational cannot arise unless
this industry falls in the hands of a MNC itself and a large
number of carpet weavers are trained on a large scale
through Carpet Management Schools which is a far off
dream. However, efforts should be made to provide more
incentives to the carpet weavers so that child labor in this
industry is completely abolished and the objection of
importers on the use of child labor is removed.

Keywords in Case 2
International Marketing is the process of focusing
resources and objectives of a company on marketing
opportunities at the international level.
38

Keywords in Case 2 (Contd.)

Transnational A Transnational corporation (TNC) is an
incorporated or unincorporated enterprise comprising of
parent enterprise and its foreign affiliates.
Parent enterprise A parent enterprise is defined as an
enterprise that controls assets of other entities in countries
other than its home country, usually by owning a 10% or
more equity capital stake.

Ethnocentricity An ethnocentric orientation in domestic

and international companies means that they pursue
marketing opportunities outside their home market by
extending various elements of the marketing mix.
39

Foreign Exchange Market Structure

Unlike stock market which is centralized, Foreign Exchange
market is decentralized. Trading Spot FX (or foreign exchange) is
decentralized. Thus called Over The Counter (OTC) market. No
central market.
Made up of price makers and price takers.
In Foreign Exchange market, there is no single price for a given
currency at any time, which means quotes from different
currency dealers vary.
The Foreign Exchange market is huge (more than $4 trillion
trading volume daily) and competition between dealers is
fierce. Thus buyers get best prices.
There are 100s of mini exchanges (ECNs). ECN stands for
Electronic Communication Network.
Even though Foreign Exchange market is decentralized, there
is a hierarchy as shown in next slide.
40

Foreign Exchange Market Structure

Central Banks

Interbank Market

Reuters & Electronic

Brokering Services (EBS)

Institutional Electronic
Communication Networks
(ECN) and Aggregators

Commercial Firms

Retail Foreign Exchange Dealers / ECNs

Speculators, Traders and Hedge Funds
41

Foreign Exchange Market Structure

Central banks (a major participant) role is to control money
supply, inflation and interest rates. They have official or
unofficial target rates for currencies.
Interbank Market has major banks like Deutsche Bank, JP
Morgan, Morgan Stanley, Goldman Sachs, Citigroup. They are
price makers. Everyone else is a price taker. Banks motive is to
collect spreads and commission on trades.
Institutional ECNs aggregate liquidity from banks. They collect
information. They act as a mini exchange for the foreign
exchange markets. Motive is commissions.
EBS handles 60% of trading volume while Reuters handles the
rest.
Commercial firms trade small amounts compared to banks.
Last in the chain are Retail Foreign Exchange dealers, Retail
ECNs, and finally speculators, traders and hedge funds.
42

Foreign Exchange Market Structure

Foreign Exchange Market has no central clearing authority.
Two types of market exist (a) Spot market, (b) Forward
market.
Spot market is of daily nature. The spot rate of exchange is
that which prevails when transactions are incurred.
Forward market is meant for future delivery. It determines
the forward exchange rate at which forward transactions are
to be honoured.
Foreign Exchange market is in continuous operation
globally.
Works 24 hours a day except weekends. Trading is from
20:15 GMT on Sunday right up to 22:00 GMT on Friday.

43

Top 10 Currency Traders

% of overall volume, May 2012
Rank

Name

Market share

Deutsche Bank

14.57%

Citigroup

12.26%

Barclays Investment Bank

10.95%

UBS AG

10.48%

HSBC

6.72%

JPMorgan

6.6%

Royal Bank of Scotland

5.86%

Credit Suisse

4.68%

Morgan Stanley

3.52%

10

Goldman Sachs

3.12%

44

Measures to Develop Foreign Exchange

Market in India
In India, Institutional framework is in place.
Foreign Exchange Regulation Act (FERA) 1973 was replaced
in 1999 by Foreign Exchange Management Act (FEMA).
Money and Securities Markets set up by Reserve Bank of
India in 1999 was expanded in 2004 to include Foreign
Exchange markets.
The Indian foreign exchange market is made up of
Authorised Dealers (generally banks), some intermediaries
with limited authorisation and end users viz., individuals,
corporates, institutional investors and others. Market making
banks (generally foreign banks and new private sector banks)
account for a significant percentage of the overall turnover in
the market.
45

Measures to Develop Foreign Exchange

Market in India
In India, the average monthly turnover in the merchant
segment of the foreign exchange market increased to
US$40.5 billion in 2003-2004 from US$27.0 billion in 20022003. In the inter-bank segment, the turnover has moved up
from US$103 billion in 2002-2003 to US$134.2 billion in
2003-2004. Consequently, the average monthly total
turnover increased sharply to US$174.7 billion in 2003-2004
from US$130 billion in the previous year.
Indias daily average foreign exchange market turnover was
$34 billion in 2007.

46