Unit 1: Financial Management in Global Context

Summary

 Knowledge of international finance is very crucial for MNCs as it helps the companies
and financial managers to decide how international events will affect the firm and the
steps companies can take to be insulated from adverse movements in exchange rates,
interest rates and inflation rates.
 An understanding of international finance has become important as the world has entered
an era of unprecedented global economic activity with worldwide production and
distribution.
 The distinguishing features in international finance which need special focus are –
foreign exchange risk, political risk, expanded opportunity sets and market
imperfections.
 The important aspect here is that MNCs that compete in the global market place must not
only be managed in such a way that they can withstand the effects of crisis in foreign
countries, but must also have the flexibility to capitalize on these crisis.
 There are five methods by which firms conduct international business activity –
licensing, franchising, joint ventures, management contracts and establishing new
foreign subsidiaries.
 The challenge for multinational managers is to find that form of international business
activity that is most consistent with his or her strategy.
 The agency problem reflects a conflict of interest between decision making managers
and the owners of the MNC. Agency costs occur in an effort to ensure that managers act
in the best interests of the owners.
 Generally, the agency costs are normally larger for MNCs than for purely domestic
firms.

Keywords

Agency Problem: Agency problem reflects a conflict of interest between decision making
managers and the owners of the MNC.

Foreign Direct Investments (FDI): Foreign direct investments are investments made for the
purpose of actively controlling property assets or companies located in host countries.

Franchising: Franchising means, a firm in one country authorizing a firm in another country to
Notes utilizes its brand names, logos etc. for some royalty payment.

Globalization: Globalization increases the ability of firms to do business across national

boundaries.
Joint Venture: Joint venture means a corporate entity or partnership that is jointly owned and
operated by two or more firms.

Licensing: The granting of permission to use intellectual property rights, such as trademarks,
patents, or technology, under defined conditions.

Management Contracts: A firms in one country agrees to operate facilities or provide other
management services to a firm in another country for an agreed upon fee.

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.

Unit2: International Monetary system

Summary

 Changes in the International Monetary System have been driven largely by the rapid
growth of private international capital flows, which first overwhelmed the Bretton
Woods fixed exchange rate system, and, since the 1980s, have had especially strong
effects on the emerging market countries.
 Increasingly the discretion of national policymakers is constrained by international
capital markets, which magnify the rewards for good policies and the penalties for bad
policies. But markets may, on occasion, overreact by responding late and excessively to
change in underlying conditions.
 The International Monetary System has had to adapt to the increasing role of private
capital flows. That process was evident in the shift towards flexible exchange rates
among the major currencies three decades ago, and it continues today, as we absorb and
react to the lessons of the emerging market crises of the last decade.
 The gold standard worked well until World War I interrupted trade flows and disturbed
the stability of exchange rate for currencies. The inter-war years from 1914-1944 were
characterized by political instabilities and financial crisis.
 The Bretton Woods System, which played a major emphasis on the stability of exchange
rates, worked from 1945–1972. However it came under mounting pressure as the post-
war growth of international trade was complemented by an even more dramatic
expansion of cross-border capital flows. These starkly revealed the difficulty of fixed
exchange rate, an open capital account, and a monetary policy dedicated to domestic
economic goals. With the leading countries unwilling to subordinate domestic policies to
 maintenance of the exchange rate, the fixed exchange rate regime among the major
economies gave way.
 Today, the flexible (floating) exchange rate is prevalent, wherein the market force, based
on demand and supply, determines a currency’s value. Both fixed and floating exchange
rates have their own advantages and disadvantage.
 The main objective of the EMS was to coordinate the exchange rate policies vis-à-vis the
non EMS currencies and to form a zone of monetary stability in Europe. It has three
components – the ERM, the ECU and the EMCF.

Keywords

European Currency Unit (ECU): The ECU is a “basket” currency based on a weighted average
of the currencies of member countries of the European Union.

Exchange Rate Mechanism: It refers to the procedure by which the EMS member countries
collectively manage their exchange rates.

Flexible or Floating System: The market force, based on demand and supply, determines a
currency’s value.

International Monetary System: The international monetary system consists of elements such
as laws, rules, agreements, institutions, mechanisms and procedures which affect foreign
exchange rates, balance of payments adjustments, international trade and capital flows.

Limited Flexibility Exchange Rate System: Limited flexibility exchange rate system attempts
to combine the best of the fixed (pegged) period and floating rate (more flexible) systems.

Pegged Exchange Rate Systems: In this system, currency values are fixed in relation to another
currency such as the US dollar, Euro or to a currency basket such as the special drawing
right(SDR).

SDR: SDR are an international reserve created by the IMF and allocated to member countries to
supplement foreign exchange reserves.

Wide Band Scheme: Wide band scheme a country pursuing more inflationary policies will find
the prices of its international goods going up, necessitating a depreciation programme to correct
the country’s balance of payments in order to slow growth and curb inflation, while eventually
risking recession.
 Unit 3: Foreign Exchange Market and Exchange Rates

Summary

 Foreign exchange is essentially about exchanging one Currency for another. The
complexity arises from three factors. Firstly, what is the foreign exchange exposure,
secondly, what will be the rate of exchange, and thirdly, when does the actual exchange
occur.
 Foreign exchange exposures arise from many different activities. A traveler going to
visit another country has the risk that if that country’s Currency appreciates against their
own, their trip will be more expensive.
 An exporter who sells his product in foreign Currency has the risk that if the value of
that foreign Currency falls then the revenues in the exporter’s home Currency will be
lower.
 An importer who buys goods priced in foreign Currency has the risk that the foreign
Currency will appreciate thereby making the local Currency cost greater than expected.
 The most, basic tools in the FX market are Spot rates and forward rates. In any FX
contract there are a number of variable that need to be agreed upon.
 A deal can be performed with a maturity of two business days ahead – a deal done on
this basis is called a Spot deal.
 In a Spot transaction the Currency that is bought will be receivable in two days whilst the
Currency that is sold will be payable in two days. This applies to all major currencies.
However most market participants want to exchange the currencies at a time other than
two days in advance but would like to know the rate of exchange now. This rate is
referred to as the forward rate.
 Interbank quotations are given a Bid and ask (offer) price. A Bid is the price in one
Currency at which a dealer will buy another Currency. An offer or ask is the price at
which a dealer will sell the other Currency. As the Bid-ask spread between leading
currencies is quite small, it allows market participants to implement sophisticated risk
management strategies.

Keywords

Arbitrage: Arbitrage is the practice of taking advantage of a price differential between two or
more markets.

Cross Rate: The exchange rate between any two non-dollar currencies is referred to as a cross
rate.
Cross Rate of Exchange: An exchange rate between two currencies that is derived from the
exchange rates of those currencies with a third Currency.

Forward Rate: The forward rate is the rate quoted by foreign exchange traders for the purchase
or sale of foreign exchange in the future.

Forward Transaction: Forward transaction is defined as an agreement to buy or sell a specified

amount of a foreign Currency any time in the future.

Indirect Quotations: Indirect quotations refer to the Price of foreign Currency in terms of one
unit of home Currency.

Pip: Pip is the smallest amount a price can move in any Currency quote.

Spot Rate: Spot rate is the theoretical yield on a zero-coupon Treasury.

Spot Transaction: Spot transaction can be defined as an agreement to buy or sell a specified
amount of a foreign Currency within two business days of the transaction.

Spread: The difference between the Bid Price and the Ask Price.