MODULE-1

International financial Environment

The Importance, rewards & risk of international finance- Goals of MNC- International
Business methods – Exposure to international risk- International Monetary system-
Multilateral financial institution
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International finance (also referred to as international monetary economics or international

macroeconomics) is the branch of financial economics broadly concerned with monetary and
macroeconomic interrelations between two or more countries. International finance examines the
dynamics of the global financial system, international monetary systems, balance of payments,
exchange rates, foreign direct investment, and how these topics relate to international trade.

Sometimes referred to as multinational finance, international finance is additionally concerned

with matters of international financial management. Investors and multinational corporations
must assess and manage international risks such as political risk and foreign exchange risk,
including transaction exposure, economic exposure, and translation exposure.

Some examples of key concepts within international finance are the Mundell–Fleming model,
the optimum currency area theory, purchasing power parity, interest rate parity, and the
international Fisher effect. Whereas the study of international trade makes use of mostly
microeconomic concepts, international finance research investigates predominantly
macroeconomic concepts.

International financial management also known as international finance is a popular concept

which means management of finance in an international business environment, it implies, doing
of trade and making money through the exchange of foreign currency.[1] The international
financial activities help the organizations to connect with international dealings with overseas
business partners- customers, suppliers, lenders etc. It is also used by government organization
and non-profit institutions.

International financial Environment- The Importance

Compared to national financial markets international markets have a different shape and
analytics. Proper management of international finances can help the organization in
achieving same efficiency and effectiveness in all markets, hence without IFM sustaining
in the market can be difficult.

Rewards & risk of international finance

Companies are motivated to invest capital in abroad for the following reasons
  Efficiently produce products in foreign markets than that domestically.

 Obtain the essential raw materials needed for production.

 Broaden markets and diversify

 Earn higher returns

What’s Special about International Finance?

1. Foreign exchange risk

a. E.g., an unexpected devaluation adversely affects your export market…

2. Political risk

a. E.g., an unexpected overturn of the government that jeopardizes existing

negotiated contracts…

3. Market imperfections

a. E.g., trade barriers and tax incentives may affect location of production…

4. Expanded opportunity sets

a. E.g., raise funds in global markets, gains from economies of scale…

International financial markets face a variety of risks and they are collectively known
as international finance risks. The premier financial institutions of the world apply various
principles and practical applications to deal with the risks of international finance. Financial risks
usually are those kind of risks which are related to finance or money. The financial risks related
to investments include capital risk, currency risk, as well as liquidity risk. The debt related risks
include interest rate risk and credit risk. 

The international insurance industry also faces a number of risks. 

The various risks that influence international financial markets usually include the
following: 

 Political risk
While most of the countries where you are likely to be doing business have stable governments,
there are concerns that you will confront. All member nations of the World Trade Organization
are committed to free trade, but protectionism is still a fact of life with some. Tariffs and quotas
may place restrictions on your ability to trade. Import and export licenses, customs duties, and
laws regulating currency control are requirements you must explore. You must also be mindful
that each country where you do business has a different political and legal system. Theft of
intellectual property and illegal knock-offs are facts of life, so be prepared.

 Financial risk
One risk of engaging in international business lies with exchange rates. This is not a factor when
your business is all domestic, but when your buyer has another currency, you must protect
yourself against losses due to exchange rate changes. Foreign exchange markets are fairly stable,
and, barring an international crisis, your risk is not great. Managing international transactions
requires extra precautions about payments. If your buyer is abroad you must take steps to assure
that you will be paid. Foreign credit insurance and letters of credit can alleviate much of the risk
of selling your products in overseas markets, since they will provide you with the knowledge of
the buyer's ability to pay.

 Economic risk
There are several economic issues that you must deal with when engaging in international
operations. If you are importing materials or products, you must take extra precautions to insure
timely delivery. Geography and economic conditions in the country you are dealing with are
factors. Mountains and oceans create international barriers that you must work into your business
plan. Economic instability may be an issue if your transactions involve businesses in third world
nations. Even if they are politically stable, they may lack the infrastructure to provide a sound
economic environment.

 Country risk

is the risk that a foreign government will default on its bonds or other financial commitments.
Country risk also refers to the broader notion of the degree to which political and economic
unrest affect the securities of issuers doing business in a particular country.
  Foreign Exchange Risk
Foreign exchange risk occurs when the value of an investment fluctuates due to changes in a
currency's exchange rate. When a domestic currency appreciates against a foreign currency,
profit or returns earned in the foreign country will decrease after being exchanged back to the
domestic currency. Due to the somewhat volatile nature of the exchange rate, it can be quite
difficult to protect against this kind of risk, which can harm sales and revenues.

 Marketrisk 

Market risk is the possibility of an investor experiencing losses due to factors that affect the
overall performance of the international financial markets in which he or she is involved

International Finance: Benefits

Some of the benefits of international finance are:

 Access to capital markets across the world enables a country to borrow during tough
times and lend during good times.
 It promotes domestic investment and growth through capital import.

 Worldwide cash flows can exert a corrective force against bad government policies.
 It prevents excessive domestic regulation through global financial institutions.
 International finance leads to healthy competition and, hence, a more effective banking
system.
 It provides information on the vital areas of investments and leads to effective capital
allocation.

Multinational corporations

(MNCs) are defined as firms that engage in some form of international business. Their managers
conduct international financial management, which involves international investing and
financing decisions that are intended to maximize the value of the MNC. The goal of their
managers is to maximize the value of the firm, which is similar to the goal of managers
employed by domestic companies. Initially, firms may merely attempt to export products to a
particular country or import supplies from a foreign manufacturer. Over time, however, many of
them recognize additional foreign opportunities and eventually establish subsidiaries in foreign
countries. Dow Chemical, IBM,Nike, and many other firms have more than half of their assets in
foreign countries. Some businesses, such as ExxonMobil, Fortune Brands, and Colgate-
Palmolive, commonly generate more than half of their sales in foreign countries. Even smaller
U.S. firms commonly generate more than 20 percent of their sales in foreign markets, including
Ferro (Ohio), and Medtronic (Minnesota). Seventy-five percent of U.S. firms that export have
fewer than 100 employees.
International financial management is important even to companies that have no
international business because these companies must recognize how their foreign competitors
will be affected by movements in exchange rates, foreign interest rates, labor costs, and inflation.
Such economic characteristics can affect the foreign competitors ’ costs of production and
pricing policies.

Goals of MNC

The commonly accepted goal of an MNC is to maximize shareholder wealth. Managers

employed by the MNC are expected to make decisions that will maximize the stock price and
therefore serve the shareholders. Some publicly traded MNCs based outside the United States
may have additional goals, such as satisfying their respective governments, creditors, or
employees. However, these MNCs now place more emphasis on satisfying shareholders so that
they can more easily obtain funds from shareholders to support their operations. Even in
developing countries such as Bulgaria and Vietnam that have only recently encouraged the
development of business enterprise, managers of firms must serve shareholder interests so that
they can obtain funds from them. If firms announced that they were going to issue stock so that
they could use the proceeds to pay excessive salaries to managers or invest in unprofitable
business projects, they would not attract demand for their stock. The focus in this text is on the
U.S.-based MNC and its shareholders, but the concepts commonly apply to MNCs based in other
countries.
The focus of this text is on MNCs whose parents wholly own any foreign subsidiaries, which
means that the U.S. parent is the sole owner of the subsidiaries. This is the most common form of
ownership of U.S.-based MNCs, and it enables financial managers throughout the MNC to have
a single goal of maximizing the value of the entire MNC instead of maximizing the value of any
particular foreign subsidiary.

International Business methods

1. Exporting

Is the selling of products to a foreign country or countries.

Advantages:

 Involves less financial risk

 Little cost or investment associated with the exception of establishing distribution
networks or local advertising
 Allows business to enter the global market gradually
 Agents are used as they have better understanding of local markets n assist in the
marketing strategies
Disadvantages:

 Loss of control over the product once it has been sold to the distributor or agent
 Lack of understanding of the firm’s history and product range

Types are:

 Direct – this involves a business selling directly to an overseas buyer (not really the end
user). They use their own sales representatives based in foreign markets or agents
 Indirect – is where business's use intermediaries to get their products into overseas
markets. Adv is that its easy and inexpensive and using the agents experience. Disad is
that the agents may be handling more than one customer so negligence can occur and
ending contracts can be a very expensive and time consuming process.

2. Foreign Direct Investment (FDI)

It’s investment that gains control of foreign assets or businesses. Method of international
expansion that gets controlling interest in property, assets or companies in other countries.
Involves higher commitment as it usually involves a transfer of money, personnel and
technology.

Methods of FDI:
 3. Relocation of Production

Important factors to consider are:

 Cost and availability – labour and raw materials

 Political stability
 Economic development

Reasons for relocating production overseas are:

 Reduce labour costs – take adv of lower wages and raw materials
 Get around trade barriers – doing this business can be consequently protected from
foreign competition
 To be closer to customers – reduces transportation costs/ respond quickly to changes in
demand

4. Management Contracts

 These are agreements where one business provides managerial assistance, technical
expertise to another organisation for a certain period of time

Advantages for business receiving assistance are:

 Good for developing nations

 Obtain skilled labour – without increased foreign investment

Advantages for business providing services:

 Get a flat fee or % of sales

 Extra income with little cash outlay
 Exposure to a foreign market

5. Licensing

Licensing is an agreement where a licensor, grants the licensee the right to use its patent,
copyright or brand name.
Advantages for licensee are:

 Has right to use a proven design – costs less than developing own

Advantages for licensor:

 Take advantage of foreign production without any ownership or investment obligations

 Learn about a new market without investing a lot time and effort
 Can overcome problem of limited resources for establishing production internationally

Disadvatanges are:

 Loss of control over asset including quality standards and distribution

 Licensing of technology can create a future competitor
 Licensee can learn the secrets and use the knowledge for own operations

6. Franchising

Franchising is the same as licensing in that the franchiser allows the franchisee to use the
trademark or brand or reputation.

It different from licensing because:

 Franchisers provide ongoing support to the franchisees including management training,

business advice and advertising
 Franchisers have more control over the sales of its products
 Used in service industry such as hotels, restaurants and real estate

Advantages are:

 Low cost, low risk way of entering new markets (franchiser)

 Ability to maintain product consistency by duplicating processes around the world (sers)
 Have access to cultural knowledge of local managers (sers)
 Get well known and proven products, operating systems and brand names (sees)
 Can often have deals arranged with suppliers, reducing costs for production (sees)

Disadvantages are:

 Difficulty in managing a large no of stores around the world

  Actions of either party affect the other
 Franchisees don’t have much flexibility

7. Acquisitions of existing operations

Firms frequently acquire other firms in foreign countries as a means of penetrating foreign
markets. Acquisitions allow firms to have full control over their foreign businesses and to
quickly obtain a large portion of foreign market share.

8. Establishing new foreign subsidiaries

Firms can also penetrate foreign markets by establishing new operations in foreign countries to
produce and sell their products. Like a foreign acquisition, this method requires a large
investment. Establishing new subsidiaries may be preferred to foreign acquisitions because the
operations can be tailored exactly to the firm's needs. Development will be slower, however, in
that the firm will not reap any rewards from the investment until the subsidiary is built and a
customer base established.

International Monetary system

Gold standard
A monetary system in which a country's government allows its currency unit to be freely
converted into fixed amounts of gold and vice versa. The exchange rate under the gold
 standard monetary system is determined by the economic difference for an ounce of gold
between two currencies. The gold standard was mainly used from 1875 to 1914 and also
during the interwar years
The use of the gold standard would mark the first use of formalized exchange rates in
history. However, the system was flawed because countries needed to hold large gold
reserves in order to keep up with the volatile nature of supply and demand for currency.
After World War II, a modified version of the gold standard monetary system, the
Bretton Woods monetary system created as its successor. This successor system was
initially successful, but because it also depended heavily on gold reserves, it was
abandoned in 1971 when U.S President Nixon "closed the gold window."

A gold standard is a monetary system in which the standard economic unit of account is based
on a fixed quantity of gold.

Three types may be distinguished: specie, exchange, and bullion. In the gold specie standard the
monetary unit is associated with the value of circulating gold coins or the monetary unit has the
value of a certain circulating gold coin, but other coins may be made of less valuable metal. The
gold exchange standard usually does not involve the circulation of gold coins. The main feature
of the gold exchange standard is that the government guarantees a fixed exchange rate to the
currency of another country that uses a gold standard (specie or bullion), regardless of what type
of notes or coins are used as a means of exchange. This creates a de facto gold standard, where
the value of the means of exchange has a fixed external value in terms of gold that is
independent of the inherent value of the means of exchange itself. Finally, the gold bullion
standard is a system in which gold coins do not circulate, but the authorities agree to sell gold
bullion on demand at a fixed price in exchange for currency.

As of 2013 no country used a gold standard as the basis of its monetary system, although some
hold substantial gold reserves.

Exchange Rate Policies

In July 1944, representatives from 45 nations met in Bretton Woods, New Hampshire to discuss
the recovery of Europe from World War II and to resolve international trade and monetary
issues. The resulting Bretton Woods Agreement established the International Bank for
Reconstruction and Development (the World Bank) to provide long-term loans to assist Europe's
recovery. It also established the International Monetary Fund (IMF) to manage the international
monetary system of fixed exchange rates, which was also developed at the conference.

The new monetary system established more stable exchange rates than those of the 1930s, a decade
characterized by restrictive trade policies. Under the Bretton Woods Agreement, IMF member nations
agreed to a system of exchange rates that pegged the value of the dollar to the price of gold and pegged
other currencies to the dollar. This system remained in place until 1972.
In 1972, the Bretton Woods system of pegged exchange rates broke down forever and was
replaced by the system of managed floating exchange rates that we have today.

The Bretton Woods system broke down because the dynamics of supply, demand, and prices in a
nation affect the true value of its currency, regardless of fixed rate schemes or pegging policies.
When those dynamics are not reflected in the foreign exchange value of the currency, the
currency becomes overvalued or undervalued in terms of other currencies. Its price—fixed or
otherwise—becomes too high or too low, given the economic fundamentals of the nation and the
dynamics of supply, demand, and prices. When this occurs, the flows of international trade and
payments are distorted.

In the 1960s, rising costs in the United States made U.S. exports uncompetitive. At the same
time, western Europe and Japan emerged from the wreckage of World War II to become
productive economies that could compete with the United States. As a result, the U.S. dollar
became overvalued under the fixed exchange rate system. This caused a drain on the U.S. gold
supply, because foreigners preferred to hold gold rather than overvalued dollars. By 1970, U.S.
gold reserves decreased to about $10 billion, a drop of more than 50 percent from the peak of
$24 billion in 1949.

In 1971, the U.S. decided to let the dollar float against other currencies so it could find its proper
value and imbalances in trade and international funds flows could be corrected. This indeed
occurred and evolved into the managed float system of today.

A nation manages the value of its currency by buying or selling it on the foreign exchange
market. If a nation's central bank buys its currency, the supply of that currency decreases and the
supply of other currencies increases relative to it. This increases the value of its currency.

On the other hand, if a nation's central bank sells its currency, the supply of that currency on the
market increases, and the supply of other currencies decreases relative to it. This decreases the
value of its currency.

The International Monetary Fund plays a key role in operations that help a nation manage the
value of its currency.

The International Monetary Fund

The International Monetary Fund (www.imf.org) is like a central bank for the world's central
banks. It is headquartered in Washington, D.C., has 184 member nations, and cooperates closely
with the World Bank, which we discuss in The Global Market and Developing Nations. The IMF
has a board of governors consisting of one representative from each member nation. The board
of governors elects a 20-member executive board to conduct regular operations.

The goals of the IMF are to promote world trade, stable exchange rates, and orderly correction of
balance of payments problems. One important part of this is preventing situations in which a
nation devalues its currency purely to promote its exports. That kind of devaluation is often
considered unfairly competitive if underlying issues, such as poor fiscal and monetary policies,
are not addressed by the nation.

OBJECTIVES OF IMF:

1.To promote exchange rate stability among the different countries.

2.Tomake an arrangement of goods exchange between the countries.

3. To promote short term credit facilities to the member countries.

4. To assist in the establishment of International Payment System.

5. To make the member countries balance of payment favourable.

6.To facilitate the foreign trade.

7. To promote the international monetary corporation.

Functions of imf:

1.MerchantOfCurrencies:-
IMF main function is to purchase and sell the member countries currencies.

2.HelpfulForTheDebtorCountries:-
If any country is facing adverse balance of payment and facing the difficulty to get the
currency of creditor country, it can get short term credit from the fund to clear the debt. The
IMF allows the debtor country to purchase foreign currency in exchange for its own currency
upto 75% of its quota plus an addition 25% each year. The maximum limit of the quota is
200%n special circumstances.

3.DeclaredOfScarceCurrency:-
If the demand of any particular country currency increases and its stock with the fund falls
 below 75% of its quota, the IMF can declare it scare. But IMF also tries to increase its supply
by these methods.

4.Purchasing :-  IMF purchases the scare currency by gold.

5. Borrowing :-  IMF borrows from those countries scare currency  who has surplus amount.

6. Permission :-  IMF allows the debtor countries to impose restrictions on the imports of
creditor country.

7. To promote exchange stability :-  The main aim of IMF is to promote exchange stability
among the member countries. So it advises the member countries to conduct  exchange
transactions at agreed rates. On the other hand one country can change the parity of the
currency. without the consent of the IMF but it should not be more than 10%. If the changes
are on large scale and IMF feels that according the circumstances of the country these are
essential then it allows. The country cannot change the exchange rate if IMF does not allow.

8. Temporary aid for the devalued currency: - When the devaluation policy is indispensable
or any country then IMF provides loan to correct the balance of payment of that country.

9. To avoid exchange depreciation: -  IMF is very useful to avoid the competitive exchange
depreciation which took place before world war.

10. Providing short terms credit to member countries for meeting temporary difficulties due to
adverse balance of payments.

11. Reconciling conflicting claims of member countries.

12. Providing a reservoir of currencies of member-countries and enabling members to borrow on

another's currency.

13. Promoting orderly adjustment of exchange rates.

14. Advising member countries on economic, monetary and technical matters.

International financial institutions (IFIs)

International financial institutions (IFIs) are financial institutions that have been established
(or chartered) by more than one country, and hence are subjects of international law. Their
owners or shareholders are generally national governments, although other international
institutions and other organizations occasionally figure as shareholders. The most prominent IFIs
are creations of multiple nations, although some bilateral financial institutions (created by two
countries) exist and are technically IFIs. Many of these are multilateral development banks
(MDB).

A multilateral development bank (MDB) is an institution, created by a group of countries, that

provides financing and professional advising for the purpose of development. MDBs have large
memberships including both developed donor countries and developing borrower countries.
MDBs finance projects in the form of long-term loans at market rates, very-long-term loans (also
known as credits) below market rates, and through grants.

The following are usually classified as the main MDBs:

1. World Bank

The World Bank Group's (WBG) mission is to reduce global poverty, increase economic growth,
and improve the quality of people's lives. The WBG is made up of five institutions:

 International Bank for Reconstruction and Development (IBRD), established in 1945

 International Development Association (IDA), established in 1960
 International Finance Corporation (IFC), established in 1956
 Multilateral Investment Guarantee Agency (MIGA), established in 1988
 International Centre for Settlement of Investment Disputes (ICSID), established in 1966

Together, these organizations provide low-interest loans, interest-free credits and grants to
developing countries for investments in education, health, public administration, infrastructure,
financial and private sector development, agriculture, and environmental and natural resource
management.

2. IMF

The International Monetary Fund (www.imf.org) is like a central bank for the world's central
banks. It is headquartered in Washington, D.C., has 184 member nations, and cooperates closely
with the World Bank, which we discuss in The Global Market and Developing Nations. The IMF
has a board of governors consisting of one representative from each member nation. The board
of governors elects a 20-member executive board to conduct regular operations.

The goals of the IMF are to promote world trade, stable exchange rates, and orderly correction of
balance of payments problems. One important part of this is preventing situations in which a
nation devalues its currency purely to promote its exports. That kind of devaluation is often
considered unfairly competitive if underlying issues, such as poor fiscal and monetary policies,
are not addressed by the nation.

3. Asian Development Bank (ADB)

 The Asian Development Bank's (ADB) mission is to help its developing member
countries reduce poverty and improve the quality of life of their people. Established in
1966, the ADB provides loans, technical assistance and grants to its developing member
countries in Asia and the Pacific. It is the third largest provider of development finance in
the region.

4. European Bank for Reconstruction and Development (EBRD)

The European Bank for Reconstruction and Development (EBRD) is a multilateral

development bank, using investment as a tool to help build market economies. Initially
focused on the countries of the former Eastern Bloc it expanded to support development
in the democracies of 30 countries from central Europe to central Asia. Besides Europe,
member countries of the EBRD are from all 5 continents (North America, Africa, Asia
and Australia see below), with the biggest shareholder being the United States, so the
name is somewhat a misnomer. Headquartered in London, the EBRD is owned by 64
countries and two EU institutions. Despite its public sector shareholders, it invests mainly
in private enterprises, together with commercial partners.

5. Inter-American Development Bank Group (IDB, IADB)

Created in 1959, the Inter-American Development Bank (IDB) is the main source of
multilateral funding for economic, social and institutional development in Latin America
and the Caribbean. It works with partners to reduce poverty and inequality and to achieve
sustainable economic growth.

6. African Development Bank (AfDB)

Created in 1964, the African Development Bank's (AfDB) mission is to help reduce
poverty, improve living conditions for Africans and mobilize resources for Africa's
economic and social development.

7. Islamic Development Bank (IsDB)

The Islamic Development Bank (IDB) is a multilateral development financing

institution located in Jeddah, Saudi Arabia. It was founded in 1973 by the Finance
Ministers at the first Organisation of the Islamic Conference (now called the Organisation
of Islamic Cooperation).

The bank officially began its activities on 20 October 1975, inspired by King Faisal.
There are 56 shareholding member states. Mohammed bin Faisal is the former president
of the IsDB.

On the 22 May 2013, IDB tripled its authorized capital to $150 billion to better serve
Muslims in member and non-member countries. The Bank continues to receive the
highest credit ratings of AAA by major rating agencies.
8. The European Investment Bank (EIB) is the European Union's nonprofit long-term
lending institution established in 1958 under the Treaty of Rome. As a "policy-driven
bank" whose shareholders are the member states of the EU, the EIB uses its financing
operations to bring about "European integration and social cohesion". It should not be
confused with the European Central Bank.

The EIB is a publicly owned international financial institution and its shareholders are the
member states of the European Union. Thus the member states set the bank's broad policy
goals and oversee the independent decision-making bodies: the board of governors and
the board of directors