International

Financial
Management

Plan:

Section I
1)The essence of international financial management
1.1 Concept and main functions of IFM
1.2 Nature & Scope
1.3 International Trade Theories
2) International Business Methods
Section II
3)General directions of International Financial Management
3.1 Capital Budgeting
3.2 Foreign portfolio investment
3.2 Working capital management
3.3 Trade Finance
3.4 Letter of credit
3.5 Bank Guarantee
3.6 Collection and discounting of bills
3.7 Dividend Police
3.8 Risk management

The essence of
international financial
management

IFM- 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.

The international financial activities help the

organizations to connect with international dealings
with overseas business partners- customers,
suppliers, lenders. It is also used by government
organization and non-profit institutions.

The essence of
international financial
management
The

main objective
management is to
wealth.

of international financial
maximise shareholder

Adam Smith wrote in his famous title, Wealth of

Nations that if a foreign country can supply us

with a commodity Cheaper than we ourselves can
make it, better buy it of them with some part of
the produce of our own in which we have some
advantage.

Basic Functions

ACQUISITION OF FUNDS (FINANCING

DECISION)
This function involves generating funds
from internal as well as external sources.
The effort is to get funds at the lowest cost
possible.

Basic Functions

-INVESTMENT DECISION
It is concerned with deployment of the

acquired funds in a manner so as to

maximize shareholder wealth.
Other decisions relate to dividend payment,
working capital and capital structure etc.
In addition, risk management involves both
financing and investment decision.

Nature & Scope

Finance function of a multinational firm
has two functions
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.

Environment at
International Level
International financial management practitioners are
required the knowledge in the following fields:
the knowledge of latest changes in forex rates
instability in capital market
interest rate fluctuations
macro level charges
micro level economic indicators
savings rate
consumption pattern
investment behavior of investors
export and import trends
Competition
banking sector performance
inflationary trends
demand and supply conditions etc.

Foreign exchange risk

In a domestic economy this risk is generally ignored because a

single national currency serves as the main medium of
exchange within a country.

When different national currencies are exchanged for each

other, there is a definite risk of volatility in foreign exchange
rates.

The present International Monetary System set up is

characterized by a mix of floating and managed exchange rate
policies adopted by each nation keeping in view its interests.

In fact, this variability of exchange rates is widely regarded as

the most serious international financial problem facing
corporate managers and policy makers

Political risk

Political risk ranges from the risk of loss (or gain) from
unforeseen government actions or other events of a
political character such as acts of terrorism to outright
expropriation of assets held by foreigners.

For example, in 1992, Enron Development Corporation, a

subsidiary of a Houston based Energy Company, signed a
contract to build
Indias longest power plant.
Unfortunately, the project got cancelled in 1995 by the
politicians in Maharashtra who argued that India did not
require the power plant. The company had spent nearly $
300 million on the project

Expanded Opportunity
Sets
When firms go global, they also tend to benefit

from expanded opportunities which are available

now.
They can raise funds in capital markets where cost

of capital is the lowest.

The firms can also gain from greater economies of

scale when they operate on a global basis

International Trade
Theories

Theory of
Mercantilism

Theory of
Comparative
Cost
Advantage
Theory of
Absolute Cost
Advantage

Theory of Mercantilism

This theory is during the sixteenth to the threefourths of the eighteenth centuries.

It beliefs in nationalism and the welfare of the

nation alone, planning and regulation of
economic activities for achieving the national
goals, restriction imports and promoting
exports.

It believed that the power of a nation lied in its

wealth, which grew by acquiring gold from
abroad.

Theory of Mercantilism
Mercantilists failed to realize that simultaneous export

promotion and import regulation are not possible in all

countries, and the mere control of gold does not
enhance the welfare of a people.
Keeping the resources in the form of gold reduces the

production of goods and services and, thereby, lowers

welfare.
It was rejected by Adam Smith and Ricardo by stressing

the importance of individuals, and pointing out that

their welfare was the welfare of the nation.

Theory of Absolute
Cost Advantage

This theory was propounded by Adam Smith (1776),

arguing that the countries gain from trading, if they
specialise according to their production advantages.

The pre-trade exchange ratio in Country I would be

2A=1B and in Country II IA=2B.

Theory of Absolute
Cost Advantage

If it is nearer to Country I domestic exchange ratio

then trade would be more beneficial to Country II and
vice versa.
Assuming the international exchange ratio is
established IA=IB.
The terms of trade between the trading partners would
depend upon their economic strength and the
bargaining power.

Theory of Comparative
Cost Advantage

Ricardo (1817), though adhering to the

absolute cost advantage principle of Adam
Smith, pointed out that cost advantage to
both the trade partners was not a necessary
condition for trade to occur.

According to Ricardo, so long as the other

country is not equally less productive in all
lines of production, measurable in terms
of opportunity cost of each commodity in
the two countries, it will still be mutually
gainful for them if they enter into trade.

Theory of Comparative
Cost Advantage

In the example given, the opportunity cost of one

unit of A in country I is 0.89 (80/90) unit of good B
and in country II it is 1.2 (120/100) unit of good B.

On the other hand, the opportunity cost of one unit

of good B in country I is 1.125 (90/80)units of good A
and 0.83 (100/120) unit of good A, in country II.

Theory of Comparative
Cost Advantage

The opportunity cost of the two goods are different in

both the countries and as long as this is the case, they
will have comparative advantage in the production of
either, good A or good B, and will gain from trade
regardless of the fact that one of the trade partners
may be possessing absolute cost advantage in both
lines of production.

Thus, country I has comparative advantage in good A

as the opportunity cost of its production is lower in this

country as compared to its opportunity cost in country
II which has comparative advantage in the production
of good B on the same reasoning.

International Business
Methods
Licensing
Franchising
Subsidiaries and Acquisitions
Strategic Alliances
Exporting

Licensing

License -means to give permission. A license may be

granted by a party ("licensor") to another party
("licensee") as an element of an agreement between
those parties.

A license may be issued by authorities, to allow an activity

that would otherwise be forbidden. It may require paying
a fee and/or proving a capability. The requirement may
also serve to keep the authorities informed on a type of
activity, and to give them the opportunity to set
conditions and limitations.

Franchising

Franchising is the practice of selling the right to use a

firm's successful business model. For the franchisor, the
franchise is an alternative to building 'chain stores' to
distribute goods that avoids the investments and
liability of a chain. The franchisor's success depends on
the success of the franchisees. The franchisee is said to
have a greater incentive than a direct employee
because he or she has a direct stake in the business.

The franchisor is a supplier who allows an operator, or a

franchisee, to use the supplier's trademark and
distribute the supplier's goods. In return, the operator
pays the supplier a fee.

Subsidiaries and
Acquisitions

A subsidiary is a company that is completely or partly owned

by another corporation that owns more than half of the
subsidiary's stock, and which normally acts as a holding
corporation which at least partly or a parent corporation, wholly
controls the activities and policies of the daughter corporation.

Mergers and acquisitions are both aspects of corporate

strategy, corporate finance and management dealing with the
buying, selling, dividing and combining of different companies
and similar entities that can help an enterprise grow rapidly in
its sector or location of origin, or a new field or new location,
without creating a subsidiary, other child entity or using a joint
venture.

Strategic Alliances

A strategic alliance is an agreement between two or

more parties to pursue a set of agreed upon objectives
needed while remaining independent organizations. This
form of cooperation lies between Mergers & Acquisition
M&A and organic growth.

Partners may provide the strategic alliance with resources

such as products, distribution channels, manufacturing
capability, project funding, capital equipment, knowledge,
expertise, or intellectual property. The alliance is a
cooperation or collaboration which aims for a synergy
where each partner hopes that the benefits from the
alliance will be greater than those from individual efforts.

Section II

General directions of
International Financial
Management

Capital Budgeting

It is the planning process used to determine whether an

organization's 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 firm's capitalization
structure.
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.

Methods of capital
Budgeting

Accounting rate of return

Payback period

Net present value

Profitability index

Internal rate of return

Modified internal rate of return

Equivalent annuity

Real options valuation

These
methods
use
the
incremental cash flows from
each potential investment, or
project

Factors influencing Capital

Budgeting

Availability of funds

Structure of capital

Taxation Policy

Government Policy

Lending Policies of Financial Institutions

Immediate need of the Project

Earnings

Capital Return

Economic Value of the Project

Working Capital

Accounting Practice

Trend of Earning

Foreign Portfolio
Investment

Foreign portfolio investment is the entry of funds into a

country where foreigners make purchases in the countrys
stock and bond markets, sometimes for speculation.

It is a usually short term investment, as opposed to the

longer term Foreign Direct Investment partnership,
involving transfer of technology and "know-how".

Foreign Portfolio Investment (FPI): passive holdings of

securities and other financial assets, which do NOT entail
active management or control of the securities' issuer. FPI
is positively influenced by high rates of return and
reduction of risk through geographic diversification. The
return on FPI is normally in the form of interest payments
or non-voting dividends.

Working Capital
Management
Working capital management is concerned with the problems that

arise in attempting to manage the current assets, the current

liabilities and the interrelations that exist between them.
Current assets refer to those assets which in the ordinary course of

business can be, or will be, converted into cash within one year
without undergoing a diminution in value and without disrupting
the operations of the firm.
Examples- cash, marketable securities, accounts receivable and
inventory.
Current liabilities are those liabilities which are intended, at their

inception, to be paid in the ordinary course of business, within a

year, out of the current assets or the earnings of the concern.
Examples- accounts payable, bills payable, bank overdraft and
outstanding expenses

Goal of Working Capital

Management

To manage the firms current assets

and liabilities in such a way that a

satisfactory level of working capital is
maintained.

Concepts and Definitions

of Working Capital
There are two concepts of working capital:
Gross and Net
Gross working capital- means the total current assets.
Net working capital- can be defined in two wayso The difference between current assets and current liabilities.
o The portion of current assets which is financed with long

term funds

Determinants of Working
capital Requirement

General nature of business

Production cycle

Business cycle fluctuations

Production policy

Credit policy

Growth and expansion

Profit level

Level of taxes

Dividend policy

Depreciation policy

Price level changes

Operating efficiency

Working capital: Policy

and Management

The working capital management includes and refers to the

procedures and policies required to manage the working
capital.
There are three types of working capital policies which a firm
may adopt :

Moderate working capital policy

Conservative working capital policy

Aggressive working capital policy.

These policies describe the relationship between the sales level
and the level of current assets.

Types of working capital

needs

The working capital need can be bifurcated into permanent working

capital and temporary working capital.

Permanent working capital- There is always a minimum

level of working capital which is continuously required by a firm in
order to maintain its activities like cash, stock and other current
assets in order to meet its business requirements irrespective of the
level of operations.
Temporary working capital- Over and above the permanent
working capital, the firm may also require additional working capital
in order to meet the requirements arising out of fluctuations in sales
volume. This extra working capital needed to support the increased
volume of sales is known as temporary or fluctuating working capital.

Trade Finance

For a trade transaction there should be a Seller to sell

the goods or services and a Buyer who will buy the
goods or use the services. Various intermediaries such
as (banks , Financial Institutions) can facilitate this
trade transaction by financing the trade.

While a seller (the exporter) can require the purchaser

(an importer) to prepay for goods shipped, the
purchaser (importer) may wish to reduce risk by
requiring the seller to document the goods that have
been shipped. Banks may assist by providing various
forms of support.

The following are the most famous

products/services offered by various
Banks and Financial Institutions in Trade
Finance Segment:

Letter of credit

Bank Guarantee

Collection and Discounting of Bills

Letter of Credit

It

is an undertaking promise given by a

Bank/Financial Institute on behalf of the
Buyer/Importer to the Seller/Exporter, that, if the
Seller/Exporter presents the complying documents
to the Buyer's designated Bank/Financial Institute
as specified by the Buyer/Importer in the Purchase
Agreement then the Buyer's Bank/Financial
Institute will make payment to the Seller/Exporter

Bank Guarantee

It is an undertaking promise given by a Bank on

behalf of the Applicant and in favour of the

Beneficiary. Whereas, the Bank has agreed and
undertakes that, if the Applicant failed to fulfill his
obligations either Financial or Performance as per
the Agreement made between the Applicant and
the Beneficiary, then the Guarantor Bank on
behalf of the Applicant will make payment of the
guarantee amount to the Beneficiary upon receipt
of a demand or claim from the Beneficiary.

Collection and
Discounting of Bills
It is a major trade service offered by the Banks.

The Seller's Bank collects the payment proceeds

on behalf of the Seller, from the Buyer or Buyer's
Bank, for the goods sold by the Seller to the Buyer
as per the agreement made between the Seller
and the Buyer.

Dividend Policy

Dividend policy is concerned with financial policies

regarding paying cash dividend in the present or paying an
increased dividend at a later stage. Whether to issue
dividends, and what amount, is determined mainly on the
basis of the company's unappropriated profit and
influenced by the company's long-term earning power.
When cash surplus exists and is not needed by the firm,
then management is expected to pay out some or all of
those surplus earnings in the form of cash dividends or to
repurchase the company's stock through a share buyback
program.

Risk Management

Risk management is the identification, assessment, and

prioritization of risks followed by coordinated and
economical application of resources to minimize, monitor,
and control the probability and/or impact of unfortunate
events or to maximize the realization of opportunities.

Risks can come from uncertainty in financial markets,

threats from project failures (at any phase in design,
development, production, or sustainment life-cycles),
legal liabilities, credit risk, accidents, natural causes and
disasters as well as deliberate attack from an adversary,
or events of uncertain or unpredictable root-cause.

Methods of risk
management
Identify, characterize threats
Assess the vulnerability of critical assets to

specific threats
Determine the risk (the expected likelihood and

consequences of specific types of attacks on

specific assets)
Identify ways to reduce those risks
Prioritize risk reduction measures based on a

strategy

Principles of risk
management

Risk management should:

create value resources expended to mitigate risk should be less than the consequence of inaction, or (as in
value engineering), the gain should exceed the pain

be an integral part of organizational processes

be part of decision making process

explicitly address uncertainty and assumptions

be systematic and structured process

be based on the best available information

be tailorable

take human factors into account

be transparent and inclusive

be dynamic, iterative and responsive to change

be capable of continual improvement and enhancement

be continually or periodically re-assessed

Conclusions

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.

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

Thank You for Attention!