Master Business Administration- MBA Semester 4 MF0015 International Financial Management Q.

.1 How does International Financial Management helps in maximizing the Wealth of the shareholders? Ans : Other than earning profit one o the main goal of any business is to maximize shareholders wealth .Shareholders is a critical aspect of the business as their capital is invested and they are the primary risk takers for the business. To analyze the returns of shareholder's and maximizing their returns to investment it is important to review different concepts in business to determine the risk-return model, profits, return on assets and equity. Thus with the analysis of various profitability measures and financial return and what they mean to shareholders, we will highlight the primary role of business to increase profits and improve returns of shareholders in addition of creation of wealth to make sure that the shareholder's trust is maintained towards business and managers. Further as conflicts may arise when deciding on to the business goals which sometimes neglects the shareholder's wealth maximization aim due to various economic conditions. Maximizing shareholder's wealth would mean to create a balance between all the aspect of business and the participants of business which includes; Management who ignores short term volatility in stock prices and aims at the long-term goals of shareholders of wealth creation, the board of directors who are responsible for undertaking various decisions of business which impacts business and shareholder's value in both medium and long term, Investors and trade analysts who drill down the business performance to project the short, medium and long term state of a business and finally the customers and employees who always have long term interest with the business for mutually benefitting associations. Measures of profitability for business. Return on equity (ROE)- it is the return on shareholder's investment for the given time period Net Income Shareholder's Equity Return on assets (ROA)-indicates what return a company is generating on the firm's investments/assets. Net Income + Interest Expense Total Assets Shareholder's equity is a summation of assets created and retained earnings which are reinvested in the business thus finally creating wealth for the shareholder's. Thus

shareholder's income is the return on equity and wealth creation is the return on assets and retained earning which in long tern created value and wealth for shareholders. Q2.Explain the major accounts and sub categories of the balance of payments statement . Ans : Introduction The balance of payments is merely a way of listing receipts and payments in international transactions for a nation. It shows the nations trading positions variations in its net position as a foreign lender or borrower and variations in its official reserve holding. Structure of Balance of Payments Accounts The balance of payments account of a nation is assembled on the doctrine of double entry book keeping. Every transaction is entered on the credit and debit side of the Income Statement and assets and liabilities on the balance sheet. However balance of payments accounting varies from the business accounting in one aspect. In business accounting debits (minus) are presented on the left side and credits (plus) are represented on the right side of the income statements. Whereas in the balance of payments accounting the practice is to present credits on the left side and debits on the right side of the balance of payments sheet. Principles If a payment is received from overseas account, it is a credit transaction. While if payment made to overseas account it is a debit transaction. The chief items presented on the credit side (plus) are exports of goods and services, transferred receipts in the form of gifts, subscription etc from overseas account, borrowings from overseas account investments by overseas account in the nation and official sale of reserve assets incorporating gold to overseas account and abroad agencies. Balance of Payments Account Receipts Credits (plus) Current Account Exports Merchandise Services Unrequited or Transfers Merchandise Services Unrequited or Transfers Capital Account Borrowings from Overseas Account Lending to Overseas Account Imports Payments Debits (minus)

Direct Investments by Overseas Account

Direct Investments in Overseas Account

Official Settlements Account Enhancement in Overseas Official Holdings Enhancement in Official Reserve of Gold and Overseas Currencies

Errors and Omissions Current Account 1. The current account of a nation incorporates all transactions associating to business in merchandise and services and unrequited transfers. 2. Service transactions comprise of costs of travel and transportation, insurance, earnings and imbursements of overseas investments etc. 3. Transfer payments associate to gifts, subscriptions, overseas aid, remittance made by private etc. received from overseas individuals account and government to overseas individuals. 4. In current account goods exports and imports are the most significant items. Merchandise exports are presented as the plus item and are computed free on board which means that cost of transportation, insurance etc. are eliminated. 5. On the right side imports are presented as a minus item and are computed based on costs, insurance and freight and are incorporated. 6. The deviation among exports and imports of a nation is its balance of visible imports; the balance of trade is likely. 7. In the contra crate, when imports surpasses exports it is not likely transaction. 8. It is but services, transfer payments or invisible items of the current account that reproduce the actual picture of the balance of payments account. 9. The balance of exports and imports of services and transfer payments is termed as the balance of hidden trade. 10. The hidden items along with perceptible item ascertain the real present account position. If exports of merchandise and services surpass imports of merchandise and services, the balance of payments is said to be likely transaction or vice versa it is not likely transaction. 11. In current account, exports of merchandise and services and the receipts of transfer payments are shown in the credit side or left hand side as they depict receipts from overseas individuals.

12. Alternatively, the imports of merchandise and services and subscriptions imbursements to overseas individuals are shown on the debits or right hand side as they depict the imbursements to overseas individuals. 13. The net value of these perceptible items balances is the balance on the current account.

Q3.Define what you mean by Forward Markets. Discuss the differences between futures options and spot options. Ans: The forward market is an over-the-counter method of trading specialized futures contracts. While the forward market has a lot in common with the futures exchange, the goal and feel of the market is much different. In most cases, forward contracts are individualized to the parties involved and never sold off to other holders. The traders generally sit down and work out the individual details of the contract rather than using basic agreements. Since the process is often face-to-face and customized to the parties, it is common for the buyer and seller to know one another. In the investment world, a future is an agreement to do something in the future. In many cases, these contracts amount to buying or selling an asset by a certain date for a specific amount. Once the future is drawn up, it may be bought and sold just like any other asset. As long as the future doesnt expire, the actual holder is rarely important. The investors goal in a futures contract is to anticipate changes in the market in order to buy or sell an asset with a beneficial exchange. For example, a stock is selling for $50 US Dollars (USD) at the time the future is sold. The contract states that within six months, the holder has the option to purchase that stock at the $50 USD price. The purchaser is hoping that price of the stock will increase and the seller is selling the option to raise immediate money against the potential loss of Differences Between Futures & Stock Options Futures and stock options are the two most widely publicized leveraged derivative instrument in the world today. In fact, futures and options are the two most widely used hedging instrument in the world as well. This have inevitably led many investors into thinking that futures and stock options are the same thing. In fact, there have been laymen investors referring to both instruments collectively as "Options Futures". Nothing can be further from the truth. Futures and options are two different things and futures trading really has nothing to do with options trading. Futures and options serve different needs in the capital market and will forever be important elements on their own in every well diversified portfolio. Even though futures and options are two different things, even since the invention of options on futures, that is, options with futures as their underlying asset, this distinction has been greatly blurred and made it all the more confusing for

beginners to futures and options trading. Q4.Define cost of capital. Discuss the approaches that are employed to calculate the cost of equity capital. Ans: Cost of capital refers to the opportunity cost of making a specific investment. It is the rate of return that could have been earned by putting the same money into a different investment with equal risk. Thus, the cost of capital is the rate of return required to persuade the investor to make a given investment. Cost of capital is determined by the market and represents the degree of perceived risk by investors. When given the choice between two investments of equal risk, investorswill generally choose the one providing the higher return. Cost of capital is an important component of business valuation work. Because an investor expects his or her investment to grow by at least the cost of capital, cost of capital can be used as a discount rate to calculate the fair value of an investment's cash flows. 1. Dividend price approach According to dividend price approach, we can calculate cost of capital just dividing dividend per share with market value of per share. This cost shows direct relationship between price of equity shares and price of dividend. Its % value shows what amount, we are giving per $ 100 share. Ke = D/P This model assumes that dividends shall be paid at a constant rate to perpetuity. It ignores taxation. Assume a $ 10/- share quoted at $ 25/-, dividend just paid of $ 2/Ke= 2/25 = 0.08 or 8% Above is simple approach, but these days, we also include inflation adjustment in calculating cost of equity capital with dividend price approach. Ke = D(1+ growth rate/100)(1+inflation rate/100) / Price of per share + (growth rate + inflation rate) Suppose, if in above example, growth rate is 5% and inflation rate is 6% , then Ke = Rs. 2 ( 1.05 X 1.06 )/$ 25 + ( 5% + 6% ) = 2 (1.113)/25 + 0.11 = 20.2% 2. The earning/price approach This approach tells that we should not co-relate dividend per share with market value per share but we should use total earning and try to co-relate it with market value of shares. We have to just write earning per share of company instead writing dividend per share. It will be helpful to void the effect of dividend policy on calculation of working capital. 3. Realised yield approach This approach is improvement in dividend price approach for calculating cost of capital. In this approach, we calculate cost of capital after analysis past payments of dividends. After this, we add

some rate of growth % in basic formula of cost of equity capital. In realised yield approach, dividend on per share will be real value not expected value. Remember the following points before applying the approaches of cost of capital:[*] Before applying any approach in company, we should see the expectation of investors. According to expectations and current earning level, we have to decide to add some % of growth and inflation in real dividend per share for calculating cost of equity capital. [*] If there is high value of credit sale and other outstanding incomes, then we can use earning or price approach for knowing correct cost of capital. Q5.Explain the techniques adopted by MNCs to reduce country risk . Ans: Firms use a variety of techniques for making country risk assessments. For example, they may use a checklist approach to develop an overall country risk rating, and some of the other techniques to assign ratings to the factors considered. Developing A Country Risk Rating A checklist approach will require the following steps: Assign values and weights to the political risk factors. Multiply the factor values with their respective weights, and sum up to give the political risk rating. Derive the financial risk rating similarly. Multiply the ratings with their respective weights, and sum up to give the overall country risk rating. Different country risk assessors have their own individual procedures for quantifying country risk. Although most procedures involve rating and weighting individual risk factors, the number, type, rating, and weighting of the factors will vary with the country being assessed, as well as the type of corporate operations being planned. Firms may use country risk ratings when screening potential projects, or when monitoring existing projects. For example, decisions regarding subsidiary expansion, fund transfers to the parent, and sources of financing, can all be affected by changes in the country risk rating. Comparing Risk Ratings Among Countries One approach to comparing political and financial ratings among countries is the foreign investment risk matrix (FIRM ). The Foreign Investment Risk Matrix (FIRM) Actual Country Risk Ratings Across Countries Some countries are rated higher according to some risk factors, but lower according to others. On the whole, industrialized countries tend to be rated highly, while emerging countries tend to have lower risk ratings. Country risk ratings change over time in response to changes in the risk factors. Incorporating Country Risk in Capital Budgeting If the risk rating of a country is in the acceptable zone, the projects related to that country deserve further consideration. Country risk can be incorporated into the capital budgeting analysis of a project by adjusting the discount rate, or by adjusting the estimated cash flows.

Adjustment of the Discount Rate The higher the perceived risk, the higher the discount rate that should be applied to the projects cash flows. Adjustment of the Estimated Cash Flows By estimating how the cash flows could be affected by each form of risk, the MNC can determine the probability distribution of the net present value of the project. Applications of Country Risk Analysis Alerted by its risk assessor, Gulf Oil planned to deal with the loss of Iranian oil, and was able to avoid major losses when the Shah of Iran fell four months later. However, while the risk assessment of a country can be useful, it cannot always detect upcoming crises. The benefits of DFI can be offset by country risk, the most severe of which is a host government takeover. To reduce the chance of a takeover by the host government, firms often use the following strategies: Use a Short-Term Horizon This technique concentrates on recovering cash flow quickly. Rely on Unique Supplies or Technology In this way, the host government will not be able to take over and operate the subsidiary successfully. Hire Local Labor The local employees can apply pressure on their government. Borrow Local Funds The local banks can apply pressure on their government. Purchase Insurance Investment guarantee programs offered by the home country, host country, or an international agency insure to some extent various forms of country risk. Q6.Define the benefits of FDI. State the cost of FDI to the home country. Ans: Benefits of FDI are Integration into global economy - Developing countries, which invite FDI, can gain access to a wider global and better platform in the world economy. Economic growth - This is one of the major sectors, which is enormously benefited from foreign direct investment. A remarkable inflow of FDI in various industrial units in India has boosted the economic life of country. Trade - Foreign Direct Investments have opened a wide spectrum of opportunities in the trading of goods and services in India both in terms of import and export production. Products of superior quality are manufactured by various industries in India due to greater amount of FDI inflows in the country. Technology diffusion and knowledge transfer FDI apparently helps in the outsourcing of knowledge from India especially in the Information Technology sector. Developing countries by

inviting FDI can introduce world-class technology and technical expertise and processes to their existing working process. Foreign expertise can be an important factor in upgrading the existing technical processes. For example, the civilian nuclear deal led to transfer of nuclear energy know-how between the USA and India. Increased competition - FDI increases the level of competition in the host country. Other companies will also have to improve on their processes and services in order to stay in the market. FDI enhanced the quality of products, services and regulates a particular sector. Linkages and spillover to domestic firms- Various foreign firms are now occupying a position in the Indian market through Joint Ventures and collaboration concerns. The maximum amount of the profits gained by the foreign firms through these joint ventures is spent on the Indian market. Human Resources Development - Employees of the country which is open to FDI get acquaint with globally valued skills. Employment - FDI has also ensured a number of employment opportunities by aiding the setting up of industrial units in various corners of India. Costs of FDI to the Home Country Against these benefits must be set the apparent costs of FDI for the home (source) country. The most important concerns center around the balance-of-payments and employment effects of outward FDI. The home country's balance of payments may suffer in three ways. First, the capital account of the balance of payments suffers from the initial capital outflow required to finance the FDI. This effect, however, is usually more than offset by the subsequent inflow of foreign earnings. Second, the current account of the balance of payments suffers if the purpose of the foreign investment is to serve the home market from a low-cost production location. Third, the current account of the balance of payments suffers if the FDI is a substitute for direct exports. Thus, insofar as Toyota's assembly operations in the United States are intended to substitute for direct exports from Japan, the current account position of Japan will deteriorate. With regard to employment effects, the most serious concerns arise when FDI is seen as a substitute for domestic production. This was the case with Toyota's investments in Europe. One obvious result of such FDI is reduced home-country employment. If the labor market in the home country is already very tight, with little unemployment (as was the case in both Japan and the United States during the 1980s), this concern may not be that great. However, if the home country is suffering from unemployment, concern about the export of jobs may arise. For example, one objection frequently raised by US labor leaders to the free trade pact between the United States, Mexico, and Canada (see the next chapter) is that the United States will lose hundreds of thousands of jobs as US firms invest in Mexico to take advantage of cheaper labor and then export back to the United States market.