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.

International finance is defined as the set of relations for the creation and using of funds (assets),
needed for foreign economic activity of international companies and countries.

The definition of international finance as the combination of monetary relations, that develop in
process of economic agreements - trade, foreign exchange, investment - between residents of the
country and residents of foreign countries, is not exhaustive. It does not reflect all the essential
features, that are generated by the set of conditions outside the company (i.e. the external
environment of the international business), which effects on their activity in practice.

International finance is one of the main subsystems of the world economy, which makes a
decisive impact on the national and global economy. At the same time, the international finance
functions as a integral system, the elements of which are:

- the international monetary system, which is characterized by the components: the national and
reserve currency, international collective currencies, the conditions of mutual convertibility,
currency parity, exchange rate, national and international regulatory mechanisms of exchange
rates ;

- international payments that serve the movement of goods and factors of production, financial
instruments, and the balance of payments, which reflect all the transactions related to
international payments;

- international financial markets and the mechanisms of trading by specific financial instruments
– currency, loans, securities;

- international taxation, as the method of mobilization of funds;

- international financial management of TNC, where international investment, risk management,

transnational financing etc. take the main place [Fig. 1.1].

To the main functions of international finance belong:

- Distribution function, which is the mechanism of international finance carries cash distribution
and redistribution of world product. Due to the international finance cash funds are created,
distributed and used, different needs of the world economy are met.

Distribution function is intended to promote the organization of the balanced and efficient global
production and development of all the sectors of the world economy with the aim of the most
complete satisfaction of necessities of the world community;
International Financial Management is a well-known term in today’s world and it is also known
as international finance. It means financial management in an international business
environment. It is different because of the different currency of different countries, dissimilar
political situations, imperfect markets, diversified opportunity sets. International Financial
Management came into being when the countries of the world started opening their doors for
each other. This phenomenon is well known by the name of “liberalization”. Due to the open
environment and freedom to conduct business in any corner of the world, entrepreneurs started
looking for opportunities even outside their country boundaries. The spark of liberalization was
further aired by swift progression in telecommunications and transportation technologies that too
with increased accessibility and daily dropping prices. Apart from everything else, we cannot
forget the contribution of financial innovations such as currency derivatives; cross-border stock
listings, multi-currency bonds and international mutual funds.

The resultant of liberalization and technology advancement is today’s dynamic international

business environment. Financial management for a domestic business and an international
business is as dramatically different as the opportunities in the two. The meaning and objective
of financial management do not change in international financial management but the
dimensions and dynamics change drastically.

Difference between Domestic and International Financial Management

Four major facets which differentiate international financial management from domestic
financial management are an introduction of foreign currency, political risk and market
imperfections and enhanced opportunity set.

Foreign Exchange: It’s an additional risk which a finance manager is required to cater to under
an International Financial Management setting. Foreign exchange risk refers to the risk of
fluctuating prices of currency which has the potential to convert a profitable deal into a loss-
making one.

Political Risks:The political risk may include any change in the economic environment of the
country viz. Taxation Rules, Contract Act etc. It is pertaining to the government of a country
which can anytime change the rules of the game in an unexpected manner.

Market Imperfection: Having done a lot of integration in the world economy, it has got a lot of
differences across the countries in terms of transportation cost, different tax rates, etc. Imperfect
markets force a finance manager to strive for best opportunities across the countries.

Enhanced Opportunity Set: By doing business in other than native countries, a business
expands its chances of reaping fruits of different taste. Not only does it enhances the opportunity
for the business but also diversifies the overall risk of a business.

Just like domestic financial management, the goal of International Finance is also to maximize
the shareholder’s wealth. The goal is not only is limited to the ‘Shareholders’ but extends to all
‘Stakeholders’ viz. employees, suppliers, customers etc. No goal can be achieved without
achieving welfare of shareholders. In other words, maximizing shareholder’s wealth would mean
maximizing the price of the share. Here again comes a question, whether in which currency
should the value of the share be maximized? This is an important decision to be taken by the
management of the organization.

International level initiatives like General Agreement on Trade and Tariffs (GATT), The North
American Free Trade Agreement (NAFTA), World Trade Organization (WHO) etc has to give
promoted international trade and given it a shape. All because of liberalization and those
international agreements, we have a buzz word called “MNC” i.e. Multinational Corporations.
MNCs enjoy an edge over other normal companies because of its international setting and best
opportunities.

International Finance has become an important wing for all big MNCs. Without the expertise in
International Financial Management, it can be difficult to sustain in the market because
international financial markets have a totally different shape and analytics compared to the
domestic financial markets. A sound management of international finances can help an
organization achieve same efficiency and effectiveness in all markets.

International Trade – Types, Importance, Advantages And Disadvantages

International trade refers to the exchange of goods and services between the countries. In simple
words, it means the export and import of goods and services. Export means selling goods and
services out of the country, while import means goods and services flowing into the country.

international trade supports the world economy, where prices or demand and supply are affected
by global events. For instance, the US changing visa policies for the software employees will
impact the Indian software firms. Or, an increase in the cost of labor in exporting country like
China could mean you end paying more for the Chinese goods in the US.

ADVANTAGES OF INTERNATIONAL TRADE

COMPARATIVE ADVANTAGE
It allows countries to specialize in producing only those goods and services, which it is good at.

ECONOMIES OF SCALE
If a country wants to sell its goods in the international market, it will have to produce more than
what is needed to meet the domestic demand. So, producing higher volume leads to economies
of scale, meaning the cost of producing each item is reduced.
COMPETITION
Selling goods and services in the foreign market also boosts the competition in that market. In a
way, it is good for local suppliers and consumers as well. Suppliers will have to ensure that their
prices and quality is competitive enough to meet the foreign competition.

TRANSFER OF TECHNOLOGY
International trade often leads to the transfer of technology from a developed nation to the
developing nation. Govt. in the developing nation often lay terms for foreign companies that
involve developing local manufacturing capacities.

MORE JOB CREATION

Increase in international trade also creates job opportunities in both countries. That’s a major
reason why big trading nations like the US, Japa, and South Korea have lower unemployment
rates.

DISADVANTAGES OF INTERNATIONAL TRADE

OVER-DEPENDENCE
Countries or companies involved in the foreign trade are vulnerable to global events. An
unfavorable event may impact the demand of the product, and could even lead to job losses. For
instance, the recent US-China trade war is adversely affecting the Chinese export industry.

UNFAIR TO NEW COMPANIES

New companies or start-ups who don’t have much resources and experience may find it difficult
to compete against the big foreign firms.

THREAT TO NATIONAL SECURITY

If a country is over dependant on the imports for strategic industries, then exporters may force it
to take a decision that may not be in the national interest.

PRESSURE ON NATURAL RESOURCES

A country only has limited natural resources. But, if it opens its doors to the foreign companies,
it could drain those natural resources much quicker.

Even though international trade has its own advantage and disadvantages, the advantages far
outweigh the disadvantages. Nowadays, international trade has become a necessity, but a country
must maintain a proper balance between imports and exports to ensure that the economy stays on
the growth track.
the IMF and its objective and functions.

The International Monetary Fund was originally created as part of the Bretton Woods system
exchange agreement in 1944.During the Great Depression, countries sharply raised barriers to
foreign trade in an attempt to improve their failing economies. The IMF was formally organized
on December 27, 1945, when the first 29 countries signed its Articles of Agreement. The
International Monetary Fund was one of the key organizations of the international economic
system; its design allowed the system to balance the rebuilding of international capitalism with
the maximization of national economic sovereignty and human welfare, also known as
embedded liberalism.

The members of the IMF are 188 members of the UN and the Republic of Kosovo All members
of the IMF are also International Bank for Reconstruction and Development (IBRD) members
and vice versa. Member countries of the IMF have access to information on the economic
policies of all member countries, the opportunity to influence other members’ economic policies,
technical assistance in banking, fiscal affairs, and exchange matters, financial support in times of
payment difficulties, and increased opportunities for trade and investment. Organization

Board of Governors: The Board of Governors consists of one governor and one alternate
governor for each member country. Each member country appoints its two governors. While the
Board of Governors is officially responsible for approving quota increases, special drawing right
allocations, the admittance of new members, compulsory withdrawal of members, and
amendments to the Articles of Agreement and By-Laws. Executive Board: 24 Executive
Directors make up Executive Board. The Executive Directors represent all 188 member-
countries. Countries with large economies have their own Executive Director, but most countries
are grouped in constituencies representing four or more countries. Managing Director: The IMF
is led by a Managing Director, who is head of the staff and serves as Chairman of the Executive
Board. The Managing Director is assisted by a First Deputy Managing Director and three other
Deputy Managing Directors. IFM 6

Voting power: Voting power in the IMF is based on a quota system. Each member has a number
of “basic votes" plus one additional vote for each Special Drawing Right (SDR) of 100,000 of a
member country’s quota. The Special Drawing Right is the unit of account of the IMF and
represents a claim to currency. Functions

The IMF works to foster global growth and economic stability.

It provides policy advice and financing to members in economic difficulties and also works with
developing nations to help them achieve macroeconomic stability and reduce poverty.

It provides balance of payments financing and the justification for official financing.

fixed exchange rate arrangements between countries.

The IMF also researched what types of government policy would ensure economic recovery.

Challenges of international financial management Financial management of a company is a

complex process, involving its own methods and procedures. It is made even more complex
because of the globalization taking place, which is making the worlds financial and commodity
markets more and more integrated. The integration is both across countries as well as markets.
Not only the markets, but even the companies are becoming international in their operations and
approach. Managers of international firms have to understand the environment in which they
function if they are to achieve their objective in maximizing the value of their firms, or the rate
of return from foreign operations. The environment consists of: 1. The international financial
system, which consists of two segments: the official part represented by the accepted code of
behavior by governments comprising the international monetary system, and the private part,
which consists of international banks and other multinational financial institutions that
participate in the international money and capital markets. 2. The foreign exchange market,
which consists of multinational banks, foreign exchange dealers, and organized exchanges where
currency futures are regularly traded. 3. The foreign country’s environment, consisting of such
aspects as the political and socioeconomic systems, and people’s cultural values and aspirations.
Understanding of the host country’s environment is crucial for successful operation and essential
for the assessment of the political risk.
The multinational financial manager has to realize that the presence of his firm in a number of
countries and the diversity of its operations present challenges as well as opportunities. The
challenges are the unique risks and variables the manager has to contend with which his or her
domestic counterpart does not have to worry about. One of these challenges, for example, is the
multiplicity and complexity of the taxation systems, which impact the MNC’s operations and
profitability. But this same challenge presents the manager with opportunities to reduce the
firm’s overall tax burden, through transfer of funds from high- to low-tax affiliates and by using
tax havens. The financing function is another such challenge, due to the multiplicity of sources
of funds or avenues of investment available to the financial manager. The manager has to worry
about the foreign exchange and political risks in positioning funds and in mobilizing cash
resources. This diversity of financial sources enables the MNC at the same time to reduce its cost
of capital and maximize the return on its excess cash resources, compared to firms that raise and
invest funds in one capital market. In a real sense MNCs are particularly situated to make the
geographic, currency, and institutional diversity work for them. This diversity, if properly
managed, helps to reduce fluctuations in their earnings and cash flows, which would translate
into higher stock market values for their shares. This observation is especially valid for the well-
diversified MNCs. This is not to suggest that the job of the manager of an MNC is easier, or less
demanding, than if he or she were to operate within the confines of one country. The challenges
and the risks are greater, but so are the rewards accruing to intelligent, flexible, and forward-
looking management. The key to such a management is to make the diversity and complexity of
the environment work for the benefit of the firm and to lessen the adverse impact of conflicts on
its progress.