International financial management

1. 1. International FinancialManagement
2. 2. Introduction The main objective of internationalfinancial management is to
maximiseshareholder wealth. Adam Smith wrote in his famous title,Wealth of Nations
that if a foreigncountry can supply us with a commodityCheaper than we ourselves can
make it,better buy it of them with some part ofthe produce of our own in which we
havesome advantage.
3. 3. Basic Functions Acquisition of funds (financing decision) This function involves
generating funds from internal aswell as external sources. The effort is to get funds at
the lowest cost possible. Investment decision It is concerned with deployment of the
acquired funds in amanner so as to maximize shareholder wealth. Other decisions
relate to dividend payment, workingcapital and capital structure etc. In addition, risk
management involves both financing andinvestment decision.
4. 4. Nature & Scope Finance function of a multinational firm has twofunctions namely,
treasury and control. The treasurer is responsible for financial planning analysis fund
acquisition investment financing cash management investment decision and risk
management Controller deals with the functions related to external reporting tax
planning and management management information system financial and management
accounting budget planning and control, and accounts receivables etc.
5. 5. Environment at International Level the knowledge of latestchanges in forex rates
instability in capitalmarket interest rate fluctuations macro level charges micro level
economicindicators savings rate consumption pattern investment behaviour
ofinvestors export and import trends Competition banking sectorperformance
inflationary trends demand and supplyconditions etc.International financial management
practitioners arerequired the knowledge in the following fields.
6. 6. International financial manager willinvolve the study of exchange rate and currency
markets theory and practice of estimating future exchange rate various risks such as
political/country risk, exchangerate risk and interest rate risk various risk management
techniques cost of capital and capital budgeting in internationalcontext working capital
management balance of payment, and international financial institutions etc.
7. 7. Features of International Finance Foreign exchange risk Political risk Expanded
opportunity sets Market imperfections
8. 8. Foreign exchange risk In a domestic economy this risk is generally ignoredbecause a
single national currency serves as the mainmedium of exchange within a country. When
different national currencies are exchanged foreach other, there is a definite risk of
volatility in foreignexchange rates. The present International Monetary System set up
ischaracterised by a mix of floating and managedexchange rate policies adopted by each
nation keepingin view its interests. In fact, this variability of exchange rates is
widelyregarded as the most serious international financialproblem facing corporate
managers and policy makers.
9. 9. Political risk Political risk ranges from the risk of loss (or gain) fromunforeseen
government actions or other events of apolitical character such as acts of terrorism to
outrightexpropriation of assets held by foreigners. For example, in 1992, Enron
Development Corporation,a subsidiary of a Houston based Energy Company,signed a

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contract to build Indias longest power plant.Unfortunately, the project got cancelled in
1995 by thepoliticians in Maharashtra who argued that India didnot require the power
plant. The company had spentnearly $ 300 million on the project.
10. Expanded Opportunity Sets When firms go global, they also tend tobenefit from
expanded opportunities whichare available now. They can raise funds in capital markets
wherecost of capital is the lowest. The firms can also gain from greatereconomies of
scale when they operate on aglobal basis.
11. Market Imperfections domestic finance is that world markets todayare highly
imperfect differences among nations laws, taxsystems, business practices and
generalcultural environments
12. International Trade Theories Theory of Mercantilism Theory of Absolute Cost
Advantage Theory of Comparative Cost Advantage
13. Theory of Mercantilism This theory is during the sixteenth to the three-fourths of the
eighteenth centuries. It beliefs in nationalism and the welfare of the nationalone,
planning and regulation of economic activitiesfor achieving the national goals, restriction
importsand promoting exports. It believed that the power of a nation lied in itswealth,
which grew by acquiring gold from abroad.Cont
14. Theory of Mercantilism Mercantilists failed to realize that simultaneous
exportpromotion and import regulation are not possible in allcountries, and the mere
control of gold does not enhance thewelfare of a people. Keeping the resources in the
form of gold reduces theproduction of goods and services and, thereby, lowers welfare.
It was rejected by Adam Smith and Ricardo by stressing theimportance of individuals,
and pointing out that their welfarewas the welfare of the nation.
15. Theory of Absolute Cost Advantage This theory was propounded by Adam Smith
(1776),arguing that the countries gain from trading, if theyspecialise according to their
production advantages. The pre-trade exchange ratio in Country I would be2A=1B and in
Country II IA=2B.Cont
16. If it is nearer to Country I domestic exchange ratiothen trade would be more
beneficial to Country IIand vice versa. Assuming the international exchange ratio
isestablished IA=IB. The terms of trade between the trading partnerswould depend upon
their economic strength and thebargaining power.Theory of Absolute Cost Advantage
17. Theory of Comparative Cost Advantage Ricardo (1817), though adhering to the
absolute costadvantage principle of Adam Smith, pointed out thatcost advantage to both
the trade partners was not anecessary condition for trade to occur. According to Ricardo,
so long as the other country isnot equally less productive in all lines of
production,measurable in terms of opportunity cost of eachcommodity in the two
countries, it will still bemutually gainful for them if they enter into trade.Cont
18. In the example given, the opportunity cost of oneunit of A in country I is 0.89
(80/90) unit of good Band in country II it is 1.2 (120/100) unit of good B. On the other
hand, the opportunity cost of oneunit of good B in country I is 1.125 (90/80)units ofgood
A and 0.83 (100/120) unit of good A, incountry II.Theory of Comparative Cost
AdvantageCont
19. The opportunity cost of the two goods are different in boththe countries and as long
as this is the case, they will havecomparative advantage in the production of either, good
A orgood B, and will gain from trade regardless of the fact thatone of the trade partners
may be possessing absolute costadvantage in both lines of production. Thus, country I

has comparative advantage in good A as theopportunity cost of its production is lower in

this country ascompared to its opportunity cost in country II which hascomparative
advantage in the production of good B on thesame reasoning.Theory of Comparative
Cost Advantage
20. 20. International Business Methods Licensing Franchising Subsidiaries and
Acquisitions Strategic Alliances Exporting