MF0006 – International Financial Management

Assignment Set-1

Q.1 Give possible reasons by which the companies are encouraged to be an MNC?
Ans: An MNC is a corporation with substantial direct investments in foreign countries and is
engaged in the active management of these offshore assets.

Some of the possible reasons by which the companies are encouraged to be an MNC are:

To broaden markets: Saturated home markets ask for market development abroad (Coca
Cola, Mac Donald’s etc.). Multinationals seek new market to fill product gaps in foreign
markets where excess returns can be earned.

To seek raw materials: Multinationals secure the necessary raw materials required to
sustain primary business line (Exxon; WalMart). Multinationals also seek to obtain easy
access to oil exploration, mining, and manufacturing in many developing nations.

To seek new technologies: Multinationals seek leading scientific and design ideas.

To seek production efficiencies by shifting to low cost regions (GE).

To avoid political hurdles such as import quota, regulatory measures of government,

trade barriers, etc.

To diversify i.e. to cushion the impact of adverse economic events.

To postpone payment of domestic taxes.

To counter foreign investments by competitors.

Q.2 What do you mean by International Trade Flows? Also explain various factors
affecting international trade flows.
Ans:
International Trade Flows
International trade is the exchange of goods and services across international boundaries.
The world trade in goods and services has grown much faster than world GDP since 1960,
global trade has grown twice as fast as the the global GDP. The share of international trade
in national economies has , in the most cases, increased dramatically over the past few
decades, In most countries, international trade represents a significant share of GDP.

Factors Affecting International Trade Flows

• Impact of Inflation: A relative increase in a country’s inflation rate will decrease its
current account, as imports increase and exports decrease.
• Impact of National Income: A relative increase in a country’s income level will
decrease its current account, as imports increase.
• Impact of Government Restrictions: A government may reduce its country’s
imports by imposing a tariff on imported goods, or by enforcing a quota. Some trade
restrictions may be imposed on certain products for health and safety reasons.
• Impact of Exchange Rates: If a country’s currency begins to rise in value, its current
account balance will decrease as imports increase and exports decrease/
Q.3 (a) Define Swaps. Also explain various types of swaps.
Ans:
Swaps
A swap is an agreement to exchange cash flows at specified future times according to
certain specified rules. The two counter parties in a swap agree to exchange or swap cash
flows at periodic intervals

The different kinds of swaps are:

• Interest Rate Swap – An exchange of fixed-rate interest payment for floating-rate

interest payments.
• Currency Swap – An exchange of interest payments and principal in one currency
for interest payment and principal in another currency.
• Cross Currency Interest Rate Swap – An exchange of floating rate interest
payment and principal in one currency for fixed rate interest payment and principal in
another currency.

(b) Define foreign bonds with their salient features.

Ans:
Foreign Bonds

A country’s foreign bond market is that market in which the bonds of issuers not domiciled in
that country are sold and traded. For example, the bonds of a German company issued in
the U.s. or traded on the U.S. secondary markets would by part of the U.S. foreign bond
market. The definition of “foreign” refers to the nationality of the issuer in relation to the
market place. For example, a US dollar bond sold in the United States by the Swedish car
producer Volvo is classified as a foreign bond while one issued by General Motors is
domestic bond.

Features of the Foreign Bonds:

1. Foreign bonds are sold in the currency of the local economy.

2. Foreign bonds are subject to the regulations governing all securities traded in the
national market and sometimes special regulations governing foreign borrowers (e.g.,
additional registration).
3. Foreign bonds provide foreign companies access to funds they often use to finance
their operations in the country where they sell the bonds.
4. Foreign bonds are regulated by the domestic market authorities. The issuer must
satisfy all regulations of the country in which it issues the bonds.
 MF0006 – International Financial Management
Assignment Set- 2

Q.1 (a) Explain the responsibilities of IMF.

Ans:
IMF

IMF is the central institution of the international monetary system. The responsibilities of IMF
are:
• To promote international monetary co-operation: prevent or manages financial crises.
• To facilitate expansion and balanced growth of international trade.
• To promote exchange rate stability.
• To assist in establishing multilateral system of payment.
• To lend to member countries experiencing balance of payment difficulties.

The IMF gets its resources from the quota countries’ pay when they join the IMF and from
periodic increases in this quota. The quotas determine a country’s voting power and the
amount of financing it can receive from the IMF.

(b) Describe two types of exchange rates.

Ans:
Floating Exchange Rate (Flexible) Regimes: A flexible exchange rate system is one
where the value of the currency is not officially fixed but exchange market in this system,
currencies are allowed to:
• Appreciate – when currency becomes more valuable relative to other.
• Depreciate – when the currency becomes less valuable relative to others.

Fixed Exchange Rate Regimes: a fixed exchange rate system is one where the value of
the currency is set by official government policy. The exchange rate is determined by
government actions designed to keep rates the same over time. The currencies are altered
by the government:

• Revaluation – Government action to increase the value of domestic currency relative

to other.
• Devaluation – Government action to decrease the value of domestic currency.

Q.2 Illustrate Political Exposure in Foreign Exchange Market?

Ans:
Management of Political Exposure

Political risk stems from political action taken by political actors that affect business. The
political actors may be the members of the government, political parties, public interest
groups that are trying to affect the political process, supra-government entities (e.g. WTO,
NAFTA) or other corporations that might act in a political way. Political action has a direct
bearing when political actors change laws, regulations, etc. or take other actions that directly
affect business. An example of such direct effect is the nationalization of business. The
indirect effect of political action occurs when the political actors change the economic
environment, the attitudes of the population, or some other factor that then indirectly affects
specific businesses. An example of such indirect effect is when the local business lobbies
the government against the entry of foreign companies.

Country risk and political risk are sometimes used interchangeably. Country risk comprises
all the socio-political and economic factors which determine the degree and level of risk
associated with undertaking business transactions in particular country; the likelihood that
changes in the business environment will occur that reduce the profitability of doing business
in a country.

Examples of political risk:

1) Nationalization: Nationalization is the appropriation of private assets by a national

government.
2) Creeping Expropriation: Creeping expropriation occurs when the government
changes the rules and makes profit impossible. An example: The host government
may require that the company sell its products only to the local enterprises and that
export opportunities are not pursued. This limits the profit potential of company.
3) Contract Repudiation: Here, the terms of operating arrangements are changed of
renegotiated once their operations are in place and have proved successful. Thus
additional taxes may be imposed. Companies with large fixed investments are
vulnerable due to the “hostage” effect. They cannot credible threaten to withdraw.
Companies with stable technologies are vulnerable because locals could take over
the operation without need for continuing foreign technology transfer.
4) Political Pressure in a Democratic System: Spread of democracy increases
popular criticism of foreign investors. Opposition parties may use attacks on foreign
investors as nationalistic position to gain voter support (but pro-business opposition
can also as tariff increases). There is evidence many believe that suppressive
authoritarian regimes are more favorable to business.
5) Threats from Local Business: Local business interests use political connections to
secure favorable treatment over foreign companies or resist market liberalization.
Many local business people become wealthy during the period of protected markets
and do not want to eliminate protectionist policies. As a result of lobbying by local
business, government may require foreign investors to have local partners or make
laws that keep foreigners entirely away from some “critical” sectors or enact licensing
procedures that delay investment. When liberalization occurs, local business still tries
to create adverse political conditions. They try to prevent foreign companies form
winning government contracts, or try to slow licensing and other approvals for foreign
companies to decrease their relative efficiency.

Q.3 Explain Trade deficits and Trade surplus in regard to Balance of Payments.
Ans:
Trade Deficits

The trade balance is the difference between a country’s output and its domestic demand-the
difference between what goods and services a country produce and how many goods and
services it buys from abroad. A trade deficit occurs when, during a certain period, a nation
imports more goods and services than it exports. A trade surplus occurs when a nation
exports more goods and services than it imports.

According to the BOP identity (Current Account+ Capital Account = Change in Official
Reserve Accounts), any trade deficit must be offset by surpluses on other accounts. Since
the official reserves are limited, a surplus on the Official Reserve Account (which means
selling of the foreign exchange reserves by the central bank) can at best be a temporary
measure. Thus the trade deficit must be “financed” by foreign income or transfers, or by a
capital account surplus. A capital account surplus consists of capital purchases (stocks,
bonds etc.) by foreign nationals. A capital account surplus (an increase in net foreign
investment) may result in an increase in the net outflow of income (dividend, interest) to
foreign nationals could have intergenerational effects: they shift consumption over time, and
future generations have to pay for the consumption by the present generation. However, a
trade deficit can also lead to higher consumption in the future, if for example, it is used to
finance profitable domestic investment, which generates returns in excess of what is paid to
the foreign nationals on their investments in the country. Such a situation may arise if a
country experiences a gain in productivity as a result of these investments.

A trade surplus implies an increase in the net international investment of residents of the
country and shifting of consumption to future rather than current generations. Even trade
surpluses can be undesirable for a country. An example where a trade surplus was not
beneficial for the country is Japan in the 1990s. The positive trade balance that Japan had
was partly due to the protectionist measures that were adopted by the Japanese
government. These measures caused the price of goods in Japan to be much higher that
what they would have been, had import been freely allowed. The foreign currency that the
Japanese companies earned overseas were kept abroad and not converted into yen in order
to keep the value of the yes low and maintain the competitiveness of Japanese exports.
However, a weak yen also prevented Japanese consumers from importing goods from
abroad and benefiting from trade surplus. The foreign exchange earned abroad as a result
of the trade surplus was party squandered by spending it on real estate purchases in the
United States that often proved unprofitable.