WEEK 1: INTRODUCTION TO IMPORTANCE

INTERNATIONAL BUSINESS 1. Earn foreign exchange

2. Optimum utilization of resources
CONTENTS 3. Achieve its objectives
• Introduction to International Business 4. To spread business risks
• Nature & Scope & Feature of International 5. Improve organization's efficiency
Business 6. Get benefits from Government
• Importance of International Business 7. Expand and diversify
• Approaches of International Business 8. Increase competitive capacity
• Problems in International Business Importance
• Entry Strategy
• Advantages & Disadvantages of International IB Approaches
Business -> Ethnocentric approach
• Reasons for recent International Business • Under this approach, target market is own
Growth country, Excessive production will export due to
• International organizations change in customer taste, preferences

What is International Business? -> Polycentric approach

• The exchange of Goods & Services, • Under this approach, the companies
Resources, Knowledge, & Skills, among customizes the marketing mix to meet the taste,
individuals & businesses in two or more performance and needs of the customers of
countries. each international market.
• Transaction that are carried out across national
-> Regio-centric approach
borders to satisfy the objectives of individuals
• Under this approach, the company operating
and organization
successfully in a foreign country thinks of
• All Commercial transactions that take place
exporting other neighboring countries of the host
between two or more countries.
country.
1. Private & Government
• At this stage, the concerned subsidiary
2. Sales
considers the regional environment (such as
3. Investments
laws, culture, policies etc.) for formulating the
4. Logistics
policies & strategies.
5. Transportation
-> Geocentric approach
NATURE
• Under this approach, the company analyses
• Accurate Information & timely
the tastes, preference and needs of the
• The size of the international business
customers in all foreign markets and then adopts
• Market segmentation
a standardized marketing mix for all the foreign
• International markets have more potential than
markets.
domestic markets
Problems
SCOPE
• Political factors
• International Marketing
• High foreign investments and high cost
• International Finance and Investments
• Exchange instability
• Foreign Exchange
• Entry requirements
• Global HR
• Tariffs, quota etc.
• Corruption and bureaucracy
FEATURES
• Technological policy
• Large scale operations
• Quality Management
• Integration of economies
• Dominated by developed countries and MNCs
• Benefits to participating countries
• Keen competition
• Special role of science and technology
• International restrictions
ENTRY STRATEGY Reason for recent growth in IB

1. Exporting 1. Expansion of technology

• Indirect & Direct 2. Business is becoming more global
2. Licensing because:
• Agreement • Transportation is quicker
• Patent, trademark, copy right, technology, • Communications enable control from afar
production processes, and product • Transportation and communications costs are
• licensee’s fee more conducive for international operations
3. Franchising
• by franchisers to franchisee 3. Liberalization of cross-border movements
• Usage • Lower Governmental barriers to the movement
4. Foreign Assembly of goods, services, and resources enable
• Subsidiary Companies to take better advantage of
• local assembly international opportunities
5. Turnkey Operation 4. General agreement on Tariff and trade
• Staff of an operating facility (GATT)
• foreign buyer • An international organization formed to reduce
6. Foreign production subsidiary or eliminate tariff and other barrier to
• Establishment international trade
• Purpose
7. International Firm 5. International Monetary Fund (IMF).
• Significant portion • An international financial organization that lend
• In foreign countries money to countries in conducting international
8. Multinational Corporation trade
• Parent country International Monetary Fund (IMF)
• host country
9. Joint Venture 6. World Bank
• Property rights • An international financial organization that lend
10. Foreign Direct Investment money to underdeveloped and developing
• Arrangement in which a firm buys or countries for development
establishes tangible assets
• In another country 7. Economic Communities
• Through direct investment • World Trade Organization (WTO)
• By buying a company stock in capital markets • European Community (EC)
• North American Free Trade Agreement
(NAFTA)
• Asian Free Trade Agreement (AFTA)
Advantages
• Faster growth
• Access to cheaper inputs
• Increased quality and efficiency
• New market opportunities
• Diversification

Disadvantages
• Increased costs
• Foreign regulations and standards
• Delays in payments
• Complex organizational structure
WEEK 2: Entry Strategies carried on within the firm; the sale is handled like
International Business domestic sales

ENTRY STRATEGIES There are several different methods of

• Market entry strategy is influenced by the indirect exporting:
firm and product characteristics and the – The simplest method is to deal with foreign
domestic and international market sales through the domestic sales organization.
characteristics. – A second form of indirect exporting is the use
of international trading companies with local
Foreign Market Entry and Operations offices all over the world.
Strategies – A third form of indirect exporting is the export
management company located in the same
Exporting country as the producing firm and which plays
• Direct Exporting. the role of an export department.
• Indirect Exporting.
Example
Contractual Agreement The mumbai based American Dry Fruits (ADF)
• Licensing & Franchising. which began selling a range of packaged foods
• Strategic Alliance. liked Chutneys, Spices, Canned vegetables,
• Contract Manufacturing. ready to eat dals, etc. under different brand
names later moved to other countries with large
Production facility in foreign Indian population.
market.
• Assembly Operations. LICENSING & FRANCHISING
• Wholly owned -> Licensing is another way to enter a foreign
manufacturing facility. market with a limited degree of risk. Under
• Joint Ventures. international Licensing, a firm in one country
permits a firm in another country to use its
Mergers and Acquisitions intellectual property (Patents, trademarks etc.)
(CONTRACT&PRODUCTION)
-> Franchising is a business model in which
DIRECT EXPORTING many different owners share a single brand
- In direct exporting, the firm becomes directly name. A parent company allows entrepreneurs
involved in marketing its products in foreign to use the company's strategies and trademarks;
markets, because the firm itself performs the in exchange, the franchisee pays an initial fee
export task (rather than delegating it to others). - and royalties based on revenues. The parent
- To implement a direct exporting strategy, the company also provides the franchisee with
firm must have representation in the foreign support, including advertising and training, as
markets. This can be achieved in a number of part of the franchising agreement.
ways:
-> Licensing is similar to franchising except that
–> Sending international sales representatives
the franchising organization tends to be more
into the foreign market.
directly involved in the development and control
–> Selecting local representatives or agents to
of the marketing programe.
prospect the market.
–> Using independent local distributors who will -> The major drawback of licensing is the
buy the products to resell them in the local problem of controlling the licensee due to the
market. absence of direct commitment from the
–> Creating a fully owned commercial subsidiary international firm granting the license. After few
to have a greater control over foreign years, once the know-how is transferred, there is
operations. a risk that the foreign firm may begin to act on its
own and the international firm may therefore
INDIRECT EXPORTING
lose that market.
-> The market-entry technique that offers the
lowest level of risk and the least market control
is indirect export, in which products are carried
abroad by others. The firm is not engaging in
international marketing and no special activity is
Example formulations. Balsara’s emphasis on Private
ITC Hotels and ITT Sheraton corporation had an label products and contract manufacturing has
agreement under which ITC Hotel’s Welcom resulted in increased business from North
group franchised two of its hotels in Bangkok American and European
and Hongkong to ITT Sheraton holding, Markets.
exchange, the franchise for Sheraton in India.
Later, partners decided to set up a joint venture ASSEMBLY OPERATIONS
with Sheraton having major stake to manage all -> Assembling is a compromise between
new ITC hotel projects in India. exporting and foreign manufacturing. The firm
produces domestically all or most of the
STRATEGIC ALLIANCE components or ingredients of its product and
-> It is an arrangement between two companies ships them to foreign markets to be put together
that have decided to share resources to as a finished product.
undertake a specific, mutually beneficial project.
A strategic alliance is less involved and less -> By shipping CKD (completely knocked down),
permanent than a joint venture, in which two the firm is saving on transportation costs and
companies typically pool resources to create a also on custom tariffs which are generally lower
separate business entity. on unassembled equipment than on finished
products. Another benefit is the use of local
-> In a strategic alliance, each company employment which facilitates the integration of
maintains its autonomy while gaining a new the firm in the foreign market.
opportunity. A strategic alliance could help a
company develop a more effective process, Example
expand into a new market or develop an Notable examples of foreign assembly are the
advantage over a competitor, among other automobile and farm equipment industries. In
possibilities. similar fashion, Coca-Cola ships its syrup to
foreign markets where local bottle plants add the
Example water and the container.
An oil and natural gas company might form a
strategic alliance with a research laboratory to WHOLLY OWNED MANUFACTURING
develop more commercially viable recovery FACILITY
processes. A clothing retailer might form a -> Companies with long term and substantial
strategic alliance with a single clothing interest in the foreign market normally establish
manufacturer to ensure consistent quality and wholly owned manufacturing facilities there. A
sizing. A major website could form a strategic number of factors like trade barriers, difference
alliance with an analytics company to improve its in the production and other costs encourage the
marketing efforts. establishment of production facilities in the
CONTRACT MANUFACTURING foreign markets.
-> In contract manufacturing, the firm’s product JOINT VENTURES
is produced in the foreign market by local Foreign joint ventures have much in common
producer under contract with the firm. Because with licensing. The major difference is that in
the contract covers only manufacturing, joint ventures, the international firm has an
marketing is handled by a sales subsidiary of the equity position and a management voice in the
firm which keeps the market control. foreign firm. A partnership between host-and
-> Contract manufacturing obviates the need for home-country firms is formed, usually resulting
plant investment, transportation costs and in the creation of a third firm.
custom tariffs and the firm gets the advantage of MERGERS & ACQUISITIONS
advertising its product as locally made. Contract From a legal point of view, a merger is a legal
manufacturing also enables the firm to avoid consolidation of two companies into one entity,
labour and other problems that may arise from whereas an acquisition occurs when one
its lack of familiarity with the local economy and company takes over another and completely
culture. establishes itself as the new owner
Example
Balsara’s private label manufacturing activity is
focused on the supply of children’s toothpaste
WEEK 3: REGIONAL ECONOMIC ALLOWING CONSUMERS TO SPEND MORE
INTEGRATION -> Economic integration reduces or eliminates
customs duties, which in turn results in cheaper
1. Regional Economic Integration (REI) refers to imported products for consumers.
the commercial policy of discriminatively -> This way, the purchasing power of
reducing or eliminating trade barriers only consumers grows, and with it, activity in the
between the states joining together. market.
2. Regional economic groups eliminate or -> The public can start buying more imported
reduce trade tariffs (and other trade barriers) products or spend former duty expenses on
among the Partner States while maintaining other products or services.
tariffs or barriers for the rest of the world -> In addition, goods that are not produced
(nonmember countries). in sufficient quantities in one country can be
3. Geographical proximity, cultural, historical, imported and distributed in the market at low
and ideological similarities, competitive or cost.
complementary economic linkages, and a
MOVEMENT OF CAPITAL
common language among the Partner States
-> The benefit of capital movement is the
are importantly required for effective economic
investment in new markets, leading to their
integration.
eventual development.
REGIONAL ECONOMIC INTEGRATION: AIM -> Economic integration removes barriers to
The aim of economic integration is to lessen foreign investors, minimizing o abolishing extra
costs for both consumers and producers, in tax, while advanced integration policies, such as
addition to increase trade between the countries a monetary union, can even eliminate the cost of
taking part in the agreement. currency exchange.

ECONOMIC INTEGRATION: ECONOMIC COOPERATION

When economies within the integrated area
Reduce costs > Monetary & Fiscal Policies < encounter problems, it is the duty of other
Increase Trade members to help, not only as a moral obligation,
but because a failing economy can have serious
REGIONAL ECONOMIC INTEGRATION: effects on the whole integration process. For this
OBJECTIVES reason, European Union countries have offered
A primary economic objective of integration is to to bail out the troubled economies of Greece,
raise: Ireland and Portugal.
a.) real output and income of the participants &
b.) rate of growth by increasing specialization REGIONAL ECONOMIC
and competition by facilitating desirable INTEGRATION: FORMS
structural (linkages) changes.
TWO SIMPLE FORMS OF REGIONAL
REGIONAL ECONOMIC INTEGRATION: INTEGRATION
OBJECTIVES
1. Increase of Trade. 1. BILATERAL INVESTMENT TREATY (BIT)
2. Allowing Consumers to Spend More. -> A bilateral investment treaty (BIT) is an
3. Movement of Capital. agreement establishing the terms and
4. Economic Cooperation conditions for private investment (FDI) by
nationals and companies of one state in another
INCREASE OF TRADE state. BITs are established through trade pacts.
A simple constituent of economic integration
policies is elimination of the additional payments
or tariffs, making trade low-priced and giving
exporters a superior incentive to do business
with integrated economies.
 FREE TRADE AGREEMENT (FTA)
-> A free-trade area is the region encompassing
a trade bloc whose member countries have
signed a free-trade agreement (FTA). Such
agreements involve cooperation between at
least two countries to abolish or reduce trade
barriers import quotas and tariffs – and to
increase trade of goods and services with each
other.

EXAMPLE
Columbia/ USA FTA

CUSTOMS UNION
-> A customs union is a type of trade bloc which
is composed of a free trade area with a common
external tariff. The tariffs are then shared among
members according to a prescribed formula.
Example - The EU (1960-1990).
2. TRADE & INVESTMENT FRAMEWORK
AGREEMENT (TIFA)
-> A trade pact between countries that seeks to
develop the necessary structures or frameworks,
such as committees and trade councils, that will
move the trading countries closer to a free trade
agreement. It is a form of economic integration.
REGIONAL ECONOMIC INTEGRATION:
FORMS
-> Regional economic groupings can take COMMON MARKET
several forms raging from the -> Members of a common market remove
1. Preferential Trade Agreement (PTA) barriers to trade in goods and services among
2. Free Trade Area (FTA) themselves, establish a common trade policy
3. Customs Union with respect to non-members (common external
4. Common Market tariff) and remove restrictions on the movement
5. Economic Union of factors of production (labor, capital, Land &
6. Political Union. entrepreneur) across borders.
These forms are diverse, involving different -> Restrictions on immigration, emigration, and
levels of economic integration. cross- border investments are abolished.
Members cooperate closely on monetary, fiscal,
and employment policies.
Example – EU since 1990s.
ECONOMIC UNION WHY MOST OF THE REI’S IS FORMED IN
-> Members of an Economic Union: SAME REGION?
1. remove barriers to trade in goods and Most trade groups contain countries in the
services among themselves; same area of the world (although not
2. establish a common trade policy with respect necessarily), for the reasons that,
to non-members (common external tariff): The distance that goods need to travel
3. remove restrictions on the movement of between such countries is short and
factors of production (labor, capital, and consumers’ tastes and preferences are likely to
technology) across borders; and be similar,
4. Coordinate their economic policies (monetary, Distribution channels can be easily established
fiscal, taxation, and social welfare) so as to in adjacent countries resulting in
blend their economies into a single entity. reduced distribution cost.
Example – • The Belgium-Luxembourg Another reason is that the neighboring
Economic Union, 1922. countries may have a common history
and interests, and they may be more willing to
POLITICAL UNION
coordinate their policies.
1. Remove barriers to trade in goods and
services among themselves; REGIONAL ECONOMIC
2. Establish a common trade policy with respect INTEGRATION: FORCES / MOTIVATIONS
to non-members (common external tariff);
3. Remove restrictions on the movement of -> FORCES / MOTIVATIONS OF REI
factors of production (labor, capital, and 1. Degree of integration depends upon the
technology) across borders; and willingness and commitment of independent
4. Coordinate their economic policies (monetary, sovereign states to share their sovereignty.
fiscal, taxation, and social welfare) so as to 2. Economic aspects and political aspects as the
blend their economies into a single entity. main motives of economic integration.
5. It involves the unification of previously
separate states. ECONOMIC ASPECTS/FORCES THAT
MOTIVATES REGIONAL ECONOMIC
INTEGRATION
Reducing uncertainties
Improving credibility
Thus making it easier for the private sector to
plan and invest.
TWO ECONOMIC EFFECTS OF REGIONAL
INTEGRATION
1.TRADE CREATION
-> Trade creation occurs when common external
trade policy and internal free trade
lead to a shift in production from high to
the low cost Partner State in the
community.
2.TRADE DIVERSION
-> Trade diversion on the other hand arises
when imports from the rest of the world
are replaced by more expensive imports from
the partner country.
The overall gain depends on whether trade
creation is larger than trade diversion.
POLITICAL ASPECTS/FORCES THAT -> The larger the integration (in terms of the
MOTIVATES REGIONAL ECONOMIC size) the more likely it is to lead to growth since
INTEGRATION the larger the integration, the larger the market
-> Many regional economic communities have created and so on. Also, the stronger the
been driven by political rather than economic potential economies of scale are, and the more
goals. rapid the autonomous productivity advances, the
more likely the integration will lead to growth.
These political objectives include:
1. National Security -> Economic integration can also serve as
2.Structure of Governance: Macroeconomic incentives for investment and attraction of
Policies Foreign Direct Investment (FDI).
3.Democracy
4.Human rights. -> General reforms such as stabilization,
market liberalization, and privatization
NATIONAL SECURITY adopted under regional arrangements can
-> Regional economic integration can enhance raise returns to all factors and are
security because it increases the level of trade likely to be more than enough to increase
between member countries and, in so doing, private investment.
increases familiarity between the people of the
member countries and lessens the degree of -> Economic integration can help to ensure that
misconception. production is located according to
comparative advantage in each member
-> It can also be a means through which states which in turn will lead to
democracy and governance objectives can be specialization which will further lead to
pursued and to lock in changes in political increased output and services thus making
institutions. the whole region better off as a result of such
-> It may also worsen security and this is likely specialization scheme.
to happen where the distribution of transfers is NEED FOR REGIONAL ECONOMIC
asymmetric between the member states. INTEGRATION IN DEVELOPING COUNTRIES
BENEFITS OF REGIONAL ECONOMIC 1. To promote a balanced division of labor
INTEGRATION among a group of countries.
-> Regional Economic Integration offers many 2. To achieve Economies of Scale.
benefits to the participating member countries. 3. Isolated tiny national economies has to give
However, these benefits are not pre- way to strategic alliances that harness
determined and they depend among other knowledge and resource based comparative
things on the internal design of the integration advantages through integration.
including the degree of political commitments by 4. One of the major problems developing
the Member States. countries face is the formulation and
implementation of good macro-economic
-> An important feature of the higher levels policies. Consequently, these countries have
of economic integration is free trade among experienced instability in their macroeconomic
members and this free trade is expected to lead environment and thus regional integration
to a rapid increase of trade which in turn is likely can help them to harmonize their macro policies,
to lead to rapid economic growth. including fiscal and monetary policy
and to achieve a stable macroeconomic
-> These gains result from the dynamic effects environment within the integrated economies.
of integration which are cumulative in nature and
lead to growth. REGIONAL ECONOMIC
INTEGRATION EXAMPLES
-> The dynamic effects of integration are often
described as the long-run consequences of EXAMPLE OF REI
economic growth of member states as a result of -> United States is the perfect example of
increased market size exploitation of economic integration - the largest economy
economies of scale increased competition comprised of fifty states in the continental United
learning by doing increased investment. States plus Alaska and Hawaii,
common currency,
perfect labor
How are Incoterms used?
capital mobility
• Incorporated in sale/purchase contracts by
and however, it is just a single country.
direct reference
EXAMPLE OF EUROPEAN UF REI : UNION • Examples of correct use:
-> The European Union is a unique economic - “FCA Port of Cork Incoterms 2010”
union between 28 European countries -“DDP Servisair Warehouse Cork Airport Cargo
that together cover much of the continent. Terminal Incoterms 2010”
• Standardized approach to a number of detailed
-> The EU is based on the rule of law: and potentially difficult commercial issues
everything it does is founded on treaties, • Significant guidance available from ICC and
voluntarily and experienced professionals
democratically agreed by its member countries.
What issues do Incoterms 2010 address?
Mobility of Factors of Production
• Transfer of risk
Growth in Living standards of people • Export clearance
Market stability : Single Market • Transport costs
Single currency : EURO • Insurance
Human rights • Use of carriers/forwarders
Equality • Import clearance
• Security-related clearances
European Union which began in 1951 of the • Electronic freight documentation
European Steel Community established Coal • They do not deal with transfer of title and
and (ECSC) by six countries, namely; The this must be agreed separately
Netherlands, Britain, Italy, Luxembourg, France
and the then West Germany. This was followed What are the 2010 Incoterms?
by the establishment of the European Economic EXW Ex Works (named place)
Community (EEC) in 1957 European Free Trade FCA Free Carrier (named places)
Association (EFTA) in 1960.These schemes and FAS Free Alongside Ship (named loading port)
more importantly the survival and apparent FOB Free on board (named loading port)
success of the EEC triggered a proliferation of CFR Cost and Freight (named destination port)
integration schemes in Latin America, Asia and CIF Cost, Insurance & Freight (named
Africa. destination port)
CPT Carriage Paid To (named place of
destination)
CIP Carriage & Insurance Paid (to) (named
place of destination)
DAT Delivered At Terminal (named terminal)
DAP Delivered At Place (named destination
WEEK 4: INCOTERMS place)
DDP Delivered Duty Paid (named destination
Incoterms 2010: Key Issues
place)
What are Incoterms? (EXW is least and DDP is most onerous for
• International Commerce Terms seller.)
• Developed by the International Chamber of
How are Incoterms 2010 arranged?
Commerce
• Incoterms 2010 arranged them into two
(headquartered in Paris, France)
groups:
• Introduced in 1936 and updated several times
(a) those suitable only for sea/inland waterway
up to 2000
transport, and
• Most recent (eighth) edition is Incoterms 2010,
(b) those suitable for all modes of transport.
effective from 1 January 2011
• FOB, FAS, CIF and CFR are suitable only for
• A set of rules governing key terms applicable
waterborne
to international trade
transport.
• A well-established shorthand to describe those
• Incoterms 2000 grouped them into four groups
terms
(E, C, F and D) where:
- Group E is EXW (the most pro-seller term)
- Group F terms make buyer liable for main
carriage
- Group C terms make seller liable for main
carriage
- Group D terms make the seller liable for arrival
Key Exporter Obligations
• The EXW term is most favourable for
sellers/exporters but does not oblige buyer to
provide any export information (which the seller
may need)
• By contrast the DDP term is most favourable
for buyers/importers and obliges the seller to
pay all transportation costs (but not insurance)
and duties and to bear all risk in the goods until
they are delivered
• The remaining terms represent a spectrum of
risk and responsibility between EXW and DDP.
Advantages of Incoterms
• Speed of negotiation
• Common understanding
• Well-designed mechanism
• Substantial caselaw applying various
circumstances
• Comprehensive
• Efficient and effective shorthand
Disadvantages of Incoterms
• Can be misapplied/misunderstood by users
• Require active consideration of some
potentially tricky issues
• Other than the above, none that we have yet
come across (but we’re still looking)!
Other important terms
• Variations from Incoterms should be clearly
and unequivocally stated.
• Warranties/disclaimers as to quality, fitness for
purpose and otherwise
should be clear and specifically agreed.
• Governing law and jurisdiction clauses
(specifying appropriate governing
law and place to resolve disputes)
• Language clauses (specifying English as
language of contract and disputes)
• Alternative dispute resolution (ADR) (principally
arbitration and mediation)
Other resources
• Professional advice available both for specific
queries and disputes Venture Legal Services
• Article on IEA website: Incoterms Explained
• International Chamber of Commerce website
WEEK 5: MANAGEMENT OF FOREIGN TECHNIQUE FOR HEDGING TRANSACTION
EXCHANGE AND RISK MANGEMENT RISK
INTRODUCTION -> A company that decide to hedge its
transaction exposure may choose any of the
-> Business firm engaged in international
following techniques:
business experience foreign exchange exposure
and risk. It may be recalled that foreign 1. Foreword hedge
exchange exposure is a sensitivity of the value
of assets, liabilities and cash flow of a firm to 2. Future hedge
change in exchange rate of currencies.
3. Money market hedge
-> The variability in the value of assets, liabilities
4. Currency option hedge
and cash flows induced by such exposure is
referred to as foreign exchange risk. Business FOREWARD HEDGE
enterprise have to design and implement proper
risk management system and methods to -> If you are going to owe foreign currency in the
reduce or eliminate the risk arising from foreign future, agree to buy the foreign currency now by
exchange exposure. entering into long position in a forward contract.
If you are going to receive foreign currency in
MANAGEMENT OF TRANSACTION RISK the future, agree to sell the foreign currency now
by entering into short position in a forward
-> Transaction risk refers to the variability in the
contract.
home currency value of cash flow arising from
transactions already completed and whose MONEY MARKET HEDGE
foreign currency values are contractually fixed.
The variability in cash flows on account of -> This is the same idea as covered interest
exchange rate fluctuations may result in a gain arbitrage. To hedge a foreign currency payable,
or loss to the firm depending on the direction of buy a bunch of that foreign currency today and
movement of exchange rates. The variability sit on it.
may be significant or insignificant depending on
the extent of movement of exchange rates. It is • It’s more efficient to buy the present value
possible to neutralize the impact of exchange of the foreign currency payable today.
rate fluctuations on cash flows and thus • Invest that amount at the foreign rate.
eliminate the variability by adopting certain -> At maturity your investment will have grown
measure. This process of eliminating variability enough to cover your foreign currency payable
is known as hedging and the measure used for
achieving objectives are known as hedging OPTION MARKET HEDGE
techniques.
Options provide a flexible hedge against the
Management of foreign exchange risk downside, while preserving the upside potential.
involves three important function
-> To hedge a foreign currency payable buy
1. Assessing the extent of variability and calls on the currency.
identifying whether it is likely to be favorable or
adverse - If the currency appreciates, your call
option lets you buy the currency at the
2. Deciding whether to hedge or not to hedge all exercise price of the call.
or part of the exposure
-> To hedge a foreign currency receivable
3. Choosing the optimal hedging technique to buy puts on the currency.
suit the situation
- If the currency depreciates, your put
option lets you sell the currency for the
exercise price.
TWO FUTURE HEDGE with each other. Flows are reduced by the lower
of each company’s purchases from or sales to
-> While the use of short and long hedges can its netting partner.
reduce (or eliminate in some cases - as below)
both downside and upside risk. The reduction of 2. Matching
upside risk is certainly a limitation of using
futures to hedge. -> The netting is typically used only for
intercompany flows arising out of groups
1. Short Hedges receipts and payments. As such, it is applicable
only to the operations of a multinational
-> A short hedge is one where a short position is company rather than exporters or importers. In
taken on a futures contract. It is typically contrast, matching applies to both third parties
appropriate for a hedger to use when an asset is as well inter-company cash flows. It can be used
expected to be sold in the future. Alternatively, it by the exporter/importer as well as the
can be used by a speculator who anticipates multinational company. It refers to the process in
that the price of a contract will decrease. which a company matches its currency inflows
2. Long Hedges with its currency outflows with respect to amount
and timing. Receipts generated in a particular
-> A long hedge is one where a long position is currency are used to make payments in that
taken on a futures contract. It is typically currency and hence, it reduces the need to
appropriate for a hedger to use when an asset is hedge foreign exchange risk exposure.
expected to be bought in the future.
Alternatively, it can be used by a speculator who 3. Leading and Lagging
anticipates that the price of a contract will -> It refers to the adjustment of intercompany
increase. credit terms, leading means a prepayment of a
CROSS HEDGING trade obligation and lagging means a delayed
payment. It is basically intercompany technique
-> A risk management strategy used in limiting whereas netting and matching are purely
or off setting probability of loss from fluctuations defensive measures. Intercompany leading and
in the prices of commodities, currencies, or lagging is a part of risk-minimizing strategy or an
securities. In effect, hedging is a transfer of risk aggressive strategy that maximizes expected
without buying insurance policies. exchange gains. Leading and lagging requires a
lot of discipline on the part of participating
-> Hedging employs various techniques but, subsidiaries. Multinational companies which
basically, involves taking equal and opposite make extensive use of leading and lagging may
positions in two different markets (such as cash either evaluate subsidiary performance in a pre-
and futures markets). Hedging is used also in interest basis or include interest charges and
protecting one's capital against effects of credits to overcome evaluation proble.
inflation through investing in high-yield financial
instruments (bonds, notes, shares), real estate, 4. Pricing Policy
or precious metals.
-> In order to manage foreign exchange risk
FOUR INTERNAL TECHNIQUES exposure, there are two types of pricing tactics:
price variation and currency of invoicing policy.
1. Netting One way for companies to protect themselves
against exchange risk is to increase selling
-> Netting implies offsetting exposures in one
prices to offset the adverse effects of exchange
currency with exposure in the same or another
rate fluctuations. Selling price requires the
currency, where exchange rates are expected to
analysis of Competitive situation, Customer
move high in such a way that losses or gains on
credibility, Price controls and Internal delays.
the firs exposed position should be offset by
gains or losses on the second currency
exposure. It is of two types bilateral netting &
multilateral netting. In bilateral netting, each pair
of subsidiaries nets out their own positions
MANAGEMENT OF OPERATING RISK MANAGING TRANSLATION EXPOSURE
-> The term Operational Risk Management Translation or Accounting Exposure:
(ORM) is defined as a continual cyclic process
which includes risk assessment, risk decision -> Is the sensitivity of the real domestic currency
making, and implementation of risk controls, value of Assets and Liabilities, appearing in the
which results in acceptance, mitigation, or financial statements to unanticipated changes in
avoidance of risk. ORM is the oversight of exchange rates Managers, analysts and
operational risk, including the risk of loss investors need some idea about the importance
resulting from inadequate or failed internal of the foreign business. Translated accounting
processes and systems; human factors; or data give an approximate idea of this.
external events. - Performance measurement for bonus plans,
THREE LEVELS OF ORM hiring, firing, and promotion decisions.

1. In Depth - Accounting value serves as a benchmark to

evaluate a discounted-cash flow valuation.
-> In depth risk management is used before a
project is implemented, when there is plenty of - For income tax purposes.
time to plan and prepare. Examples of in-depth - Legal requirement to consolidate financial
methods include training, drafting instructions statements
and requirements, and acquiring personal
protective equipment.
2. Deliberate
-> Deliberate risk management is used at routine
periods through the implementation of a project
or process. Examples include quality
assurance, on-the-job training, safety briefs,
performance reviews, and safety checks.
3. Time Critical
-> Time critical risk management is used during
operational exercises or execution of tasks. It is
defined as the effective use of all available
resources by individuals, crews, and teams to
safely and effectively accomplish the mission or
task using risk management concepts when time
and resources are limited. Examples of tools
used includes execution check-lists and change
management. This requires a high degree of
situational awareness
BENEFITS OF ORM
1. Reduction of operational loss.
2. Lower compliance/auditing costs.
3. Early detection of unlawful activities.
4. Reduced exposure to future risks