INTERNATIONAL

FINANCIAL
MANAGEMENT
 CONCEPT
• Introduction to International Financial Management

• International Monetary System

• International investment strategies

• Balance of payments

• International Payments

• Foreign Exchange Rate

• Exchange Rate Determination

• Global Financial Markets

 Concept

• International finance is the study of monetary interactions that

transpire between two or more countries.

• International finance focuses on areas such as foreign direct

investment and currency exchange rates.

• Increased globalization has magnified the importance of

international finance.

• International finance is 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.

 MEANING, FUNCTIONS, IMPORTANCE &
CHALLENGES OF IFM
Functions –
Meaning – Importance – Challenges –
1. Acquisition of
• Art of • Increase growth & sales • Foreign laws &
funds (financing
managing decision) – • Increased accessibility regulations

money on a generating funds

• • International
Rise in the local free
from different
global scale. accounting
sources
deals areas
• Management • Cost calculation &
2. Investment • Increased availability of
of financial decision – pricing strategy
capital & labor
activities at deployment of
• Development in • Currency fluctuation
acquired funds to
international
maximize the communication • Cultural disparity &
level shareholders wealth
strategy communication gap
 DOMESTIC FICNANCIAL MANAGEMENT V/S
INTERNATIONAL FINANCIAL MANAGEMENT
S.
Basis DFM IFM
no.

1 Currency Single Many

Exchange rate
2 Indirect impact Direct impact
fluctuation

3 Language Single Multiple

4 Role of govt. Favourable or easy Complex

Market
5 Low High
imperfections

6 Laws Local International

7 Political risk Low High

 MEANING OF INTERNATIONAL MONETARY SYSTEM

It refers to a system that forms rules and standards for facilitating

international trade among the nations.

An international monetary system is a set of internationally agreed

rules, conventions and supporting institutions that
facilitate international trade, cross border investment and generally
the reallocation of capital between nation states.

It refers to set of policies, institutions, practices, regulations and

mechanism that determines the rate at which one currency would be
exchange to another.
 FEATURES & ESSENTIALS OF IMS
Features - Essentials -
Adjustment
Efficient flow of
trade Easy investment • Adjust imbalances in BOP’s quickly and at
internationally relatively lower cost

Stability & confidence

Promote BOP
Stability in forex • Stability in exchange rate which turns into
adjustment
increase confidence of investors to invest in
stable market

Avoid Liquidity
Provide liquidity
uncertainties
• Must provide enough reserves assets for a
nation to correct its BOP’s deficits
 EVOLUTION OF IMS
Bimetallism Classical gold standard Interwar period
(Before 1875) (1875-1914) (1915-1944)
World war-I was ended the gold standard in
In this period, the exchange rate b/w 1914, as major countries imposed
Gold & silver coins were used as countries determined by gold content embargos (i.e., stop doing business with
international means of payment countries) on gold export

This period described as “de-globalisation”

Participants – Germany, France, U.K., U.S.A.
And great depression period
The exchange rate among currencies of
different countries were determined either
by gold or silver content Suppose, 1 ounce of gold = 6 pound
1 ounce of gold = 12 Francs Countries began to depreciate their
Then, 1 pound = 2 francs currencies to be able to export more
Wil be the exchange rate

Gresham’s Law implied that it would be the

least valuable metal that would tend to Shortcoming – central banks were
Major participants – Britain, France,
circulate. restricted not to issue more currency than
Germany, Russia
gold reserves
 Smithsonian
Bretton woods agreement Flexible exchange rate
agreement
(1945-1972) regime (1973-till now)
1971

Named after a year of 1944, meeting of 44 An agreement was made by Flexible exchange rates were declared acceptable
nations at Bretton Woods, New Hampshire initiated G-10 countries which ended to the IMF members
by John Maynard, Keynes and Harry Dexter White. the fixed exchange rate
system established under
the Bretton wood
agreement
Central banks were allowed to intervene in the
The goal was exchange rate stability without the
exchange rate markets to iron out unwarranted
gold standard
volatilities

There was an use of US

The result was the creation of International dollar for set exchange rate Gold was abandoned as an international reserve
monetary fund & World bank instead of gold & silver asset
content

The U.S. dollar was pegged to gold at $35 per

Non-oil-exporting countries and less-developed
ounce and other currencies were pegged to the
countries were given greater access to IMF funds
U.S. dollar

G:10 – Belgium, Canada,

France, Germany, Italy,
Objectives – stability in exchange rate, promoting Japan, U.K., Netherlands,
employment, freedom for govt. to pursue Sweden, US Currency are no longer backed by gold
domestic policies, provide capital reconstruction
etc.
CURRENT EXCHANGE RATE ARRANGEMENTS

• Free float – allow market forces to determine the currency’s value

• Managed float – govt. intervention with market forces to set the

exchange rate

• Pegged (fix) to another currency – U.S. dollar fix the currency’s

value

• No national currency – some countries do not bother printing

their own, they just use the U.S. dollar

 FIXED V/S FLEXIBLE EXCHANGE RATE REGIME
S.
BASIS FIXED FLEXIBLE
no.
Refers to rate which the govt. set & Refers to rate that determine by
1 Meaning
maintain at the same level market forces & may be fluctuate
Market forces such as demand &
2 Determined by Government & central bank
supply
Changes in
3 Devaluation & revaluation Depreciation & appreciation
currency prices
Takes place when there is rumour
4 Speculation Very common
about the changes in govt. policies
Operates to remove external
Self-adjusting Operates through variation in supply
5 instability by change in forex rate
mechanism of money, domestic interest rate
determined by market forces
EXCHANGE RATE REGIMES (policy framework for forex)

Regime Types Description

No separate Dollarization; use another nation’s currency as the

Fixed
legal tender medium of exchange (US$)

Monetary union; use a currency of a group of

Shared currency Fixed
countries as the medium of exchange

Currency board Use another currency in reserve as the monetary

Fixed
system base, maintaining a fixed parity

Fixed parity/rate Use another currency or basket of currencies in

Fixed
system reserve, but with some discretion (parity bands)

Fixed parity (peg) with fixed horizontal intervention

Target zone Fixed
bands
 Regime Types Description

Adjust the exchange rate against single currency,

Active & passive
Peg with adjustment for inflation (passive) or announced
crawling
in advance (active)

Fixed parity with

Peg Similar to target zone, but bands can be widened
crawling

Allow exchange rate to float, but intervene to

Managed float Float
manage it toward targets

Independently Exchange rate is market determined (supply &

Float
floating rates demand)
 INTERNATIONAL MONETARY FUND
Meaning – Functions –
The International Monetary Fund (IMF) is an • Economic & financial
organization of 190 countries, working to foster
surveillance
global monetary cooperation, secure financial
• Technical assistance & training
stability, facilitate international trade, promote

high employment and sustainable economic • Lend the money

growth, and reduce poverty around the world. • Expand & grow the

international trade

• Solve BOP deficit

 Sources of International Finance

Commercial bank International FDI

Agencies & International Capital Market
Development

Includes Exim FCCB

Global CB provides is an
loans in foreign bank, Int. is a type of
financial investment
currency to ADR
GDR convertible bond made by a firm
companies corp., Asian issued in a currency
DB provides are the stocks of the foreign is an instrument in or individual in
different than the one country
E.g. – Standard loans in companies which are traded in the which a company issuer's domestic
Chartered USA foreign located in domestic into business
American markets and are purchased currency. In other interests
currency to country issues one or words, the money
companies
by the investors in U.S. dollars during more of its shares or located in
being raised by the another
the normal trading hours in the U.S. convertibles bonds issuing company is
outside the domestic country.
market through the brokers which in the form of
country. foreign currency
allows the people of America to invest
in foreign companies.
FACTORS INFLUENCING CHOICE OF SOURCE
OF FUNDS
Cost (of
obtaining &
utilizing)

Credit Financial
worthiness strength

Tax benefit Factors Risk involved

Form of
Control over
organisation
mgmt.
& reputation

Purpose &
duration
 FDI
• Stands for foreign direct investment

• An investment made by a company or entity based in one

country into a company or entity based in another country

• Also defined as cross-border investment made by a resident in

one economy in an enterprise in another country

• It occurs when a firm invest directly in new facilities to produce or

market in a foreign country

 METHODS BENEFITS DISADVANTAGES
Host
Business
country
Acquiring voting Foreign control
stock in a foreign Market Economic
company diversification development Displacement of local
business
Merger & Tax incentives
Devp. Of human
capital
acquisition Loss of domestic jobs

Lower labour Increase in

Joint ventures with cost employment Effect on local culture
foreign corporation
Preferential
Access to mgmt. Unfavourable effect on
expertise, skills
tariffs
& technology BOP
Starting a subsidiary
of a domestic firm
in a foreign country Subsidies
High cost
 TYPES OF FDI
Types

Horizontal Vertical Conglomerate Platform

A business expands into a foreign

country by moving to a different
A business expands its domestic
level of supply chain. A business expands into foreign
operations to a foreign country. A business acquires an unrelated
e.g. – Mc’D could purchase a business in a foreign country. country but the output from the
e.g. – Mc’D open restaurants in foreign operations is exported to a
large-scale farm in Canada to
Japan, apple invest in Samsung, e.g. – Walmart invested in BMW third country
produce meat for their
Nike invest in Puma
restaurants, Hershey invest in
Alibaba
 CROSS-CURRENCY MANAGEMENT
• A cross currency refers to a cross currency pair that consists of a pair of currencies traded
in forex that does not include the U.S. dollar.

• Common cross currency pairs involve the euro and the Japanese yen.

• At the end of the Second World War, most currencies were pegged and quoted against
the U.S. dollar. This was because the U.S. economy in general was the strongest post-war
and its currency was fixed to gold. This set precedents when converting two currencies
that weren't U.S. dollars.

• Historically, an individual who wished to exchange a sum of money into a different

currency would be required first to convert that money into U.S dollars and then convert
 BALANCE OF PAYMENTS
Why BOP is vital for a Elements – Two sides –
Meaning –
country? • Credit side –
It is a systematic record of Current
• Reveals a country’s financial A/c all the inflows
all economic transaction & economic status (goods & or receipts of
services)
(i.e. transaction in goods, • Indicates currency forex are

appreciation & depreciation Capital recorded

services & assets) b/w the
A/c
• Assist govt. to decide on • Debit side –
residents of a country and (assets)
fiscal & trade policies all the
the rest of the world outflows or
• Provide info to analyse &
Financial A/c
during an accounting year understand the economic (investments
payments of
& tangibles ) forex are
dealings
recorded
 STRUCTURE OF BOP
CURRENT A/C

Credit items Debit items

Goods exported Goods imported

Services exported Services imported

Investment income received by residents Investment income paid by non-residents

Unilateral transfer receipts (gift, donation, aids etc.) Unilateral transfer payments

CAPITAL A/C

Borrowings (by private firms & govt.) Lending (by private firms & govt.)

Sale of assets (or gold) Purchase of assets (or gold)

 BALANCE OF PAYMENT V/S BALANCE OF TRADE
s.
Basis BOT BOP
no.

Records of economic transaction b/w

Measure export & import that a
1 Meaning resident of a country with the rest of
country does with other country
the world

BOT + Foreign investment + cash

2 Calculation Export - Import
transfer from abroad + capital A/c

3 Scope Smaller Wider

Find out net profit/loss on country’s All transaction have been recoded or
4 Purpose
export & import transaction not

5 Ideal result Positive Zero balancing

6 Favourable Export>Import Surplus in current A/c

7 Components Current a/c of BOP Current & capital a/c

Not true due to incomplete

8 Indicator True
 BOP also includes
• Statistical discrepancy – it includes when there is error & omission in

BOP. It refers to estimate the forex flow on account of either variation in

collection of related figures or unrecorded illegal transaction of forex.

• Official reserve a/c – net amount of transaction by government. It

includes purchase and sale of reserves SDR (special drawing rights is an

interest-bearing international reserve asset created by the IMF in 1969

to supplement other reserve assets of member countries), gold,

convertible foreign exchange.

 BOP Identity
• When the BOP A/c’s identity are recorded correctly the combined balance of the
current A/c, capital A/c and official reserves A/c must be zero i.e.

• BCA+BKA+BORA = 0

where, BCA = Balance of current A/c

BKA = Balance of capital A/c

BORA = Balance of official reserves A/c

• This equation is the BOP identity that must necessary hold

• The BOPI equation indicates that a country can run a BOP surplus or deficit by
increasing or decreasing its official reserves.
 Why BOP always balanced ?
• Because it is based on double-entry system where total of
debit is always equal to total of credit.

• In this accounting sense, balances of payments for a

country must always balance. The debit side shows the
use of total foreign exchange acquired in a particular
period. The credit side shows the sources from which the
foreign exchange is acquired during a particular period.
 Disequilibrium BOP
• When a country’s current account is at a deficit or surplus, its BOP

is said to be in disequilibrium.

• A balance of payments disequilibrium can occur when there is an

imbalance between domestic savings and domestic investments. A

deficit in the current account balance will result if domestic

investments is higher than domestic savings, since the excess

investments will be financed with capital from foreign sources.

 DISEQUILIBRIUM BOP TYPES

Temporary/
Cyclical Secular Structural Fundamental Technological
random

A change in foreign
Some phases in Because of long-run demand for exports
business cycle like and deep-seated can arise from a Due to technological
prosperity, depression changes in an change in technology, changes - inventions
etc. economy the invention of the For short-term or innovations of new
cheaper substitute. or temporary Due to goods or new
continuous techniques of
deficit production
a change in supply
can arise from the
As it moves from one dislocation of
This phases effects
stage of development production because of
the demand & supply
to another strikes or other
political punches or
natural calamities.

International
Due to excessive political Affect the demand for
investment, happening, out goods and productive
Demand & supply break of wars factors
technological
Which causes surplus conditions of exports etc Due to IMF
changes, population
or deficit in BOP may alter at home &
growth, growth of
abroad level
markets, changes in
resources, etc
 CAUSES & REMEDIAL
CAUSES REMEDIAL

Economic factors – imbalance b/w export & import, Export promotion

recession & depression, high domestic prices leads to
more imports, changes in exchange rate, inflation &
deflation etc. Restrict import

Political factors – political instability, disturbance Substitute of import

causes large capital outflows & hinder inflows of
foreign capital etc.
Reducing inflation

Exchange control
Natural Factors – natural calamities, disasters etc.
Devaluation (means fall in the external (exchange) value of domestic
currency in terms of a unit of foreign exchange which makes domestic goods
cheaper for the foreigners) of domestic currency

Social factors – change in taste & preferences, Depreciation

change in fashion, new substitute for exports,
development of alternative source of supply etc.
Monetary and fiscal changes
 HEDGING
• Hedging, in finance, is a risk management strategy.
• It deals with reducing or eliminating the risk of uncertainty.
• The aim of this strategy is to restrict the losses that may arise due to
unknown fluctuations in the investment prices and to lock the profits
therein.
• It works on the principle of offsetting i.e. taking an opposite and equal
position in two different markets.
• In simple terms, it is hedging one investment by investing in some
 Example of Hedging
• When you buy a life insurance policy, you support and secure your
family’s future in case of your death or any serious injury in some
accident.
• Similarly, when you secure your ‘A’ investment’s loss by offsetting
it with ‘B’ investment’s profit, it is known as ‘Hedging’.
 TYPES OF HEDGING
Forward Contract: It is a non-standardized Futures Contract: It is a standardized agreement
agreement to buy or sell underlying assets at a to buy or sell underlying assets at a determined
determined price on the date agreed by two price on the specific date and standardized quantity
independent parties involved. Forward contract agreed by two independent parties involved. A
covers various contracts like forward exchange futures contract covers various contracts like
contracts for currencies, commodities, etc. commodities, currencies future contracts, etc.

Money Markets: It is one of the major components

of financial markets where short-term lending,
borrowing, buying and selling is done with the
maturity of one year or less. It covers many forms of
financial activities of currencies, money market
operations for interest, calls on equities where short-
term loans, borrowing, selling and lending happen
with a maturity of one year or more.
 FOREIGN EXCHANGE
• The term Foreign exchange implies two things: a)foreign
currency and b) exchange rate
1. Foreign exchange generally refers to foreign currency, e.g. for
India it is dollar, euro, yen, etc.… &
2. the other part of foreign exchange is exchange rate which is
the price of one currency in terms of the other currency.
• Forex is the international market for the free trade of currencies.
Traders place orders to buy one currency with another currency.
 Foreign exchange market
• Foreign exchange market is that market in which national
currencies are traded for one another..
• The major participants in this market are commercial banks, forex
brokers, and authorized dealers and the monetary authorities.
• Besides, transfer of funds form one country to another ,
speculation is an important dimension of foreign exchange
market.
• Its where money in one currency is exchanged for another
 • It’s already the world’s largest market and it’s still
Advantages of Forex
growing quickly

• It makes extensive use of information technology –

making it available to everyone

market

• Traders can profit from both strong and weak economies

• Trader can place very short-term orders – which are

prohibited in some other markets

• The market is not regulated

• Brokerage commissions are very low or non-existent

• The market is open 24 hours a day during weekdays

 TYPES OF EXCHANGE RATE
Fixed & floating Direct & indirect Spot & forward
exchange rate exchange rate rate

Direct currency quote- uses the

domestic or home currency as the
base. For example, for an Spot – as a name suggest the
Fixed rate – set by government
American national, the direct exchange settle on the spot
currency quote to obtain Euros
will look like USD/EUR 1.17

Indirect - the value of our home

Forward – as a name suggest the
Floating/ flexible rate – set by currency is expressed in terms of
exchange settle on future date
market factors – demand & supply the foreign currency sought to be
but contract made today
acquired or sold.
 ASK & BID RATE
• A bid indicates the demand while ask indicates the supply of stock.

• For example, a stock quotation has a bid price of $9.10 and an ask price of $9.17.

• In this case, the buyer is willing to buy it for $9.10, while the seller is willing to sell it for $9.17.

• The difference between the two i.e. 0.07 is the spread.

• At the point, when this spread becomes zero, a transaction between buyer and seller happens.

• For example, in our case, if the buyer decides to increase the price for the sake of buying this

share to $9.17 from $9.10 or vice versa, a transaction will take place between these parties.

• Bid is the maximum price that a potential buyer is willing to spend for a specific share. Ask

price, on the other hand, is the minimum price that the seller is asking for a share.
 Interest rate parity theory
THEORIES OF INTERNATIONAL • The interest rate of different countries are remain same
• No restriction in moving money from one country/economy to another

Fischer effect
• Given by famous American economists Irving Fischer
• A change in the expected inflation rate causes the same proportionate change in the nominal interest
rate
• It describes casual relationship b/w nominal interest rate & inflation rate i.e. negative relationship
TRADE

• i = nominal interest rate

• r = real interest rate
•  = expected inflation rate

International Fischer effect

• A country with a higher interest rate will have a higher rate of inflation ultimately it causes its currency to
depreciate
• The difference in returns between the home country and a foreign country is just equal to the difference
in inflation rates.

Expectation theory
• ‘Today’s forward rate’ is going to be the ‘future spot rate’.
• Long-term rates can be used to indicate where rates of short-term bonds will trade in the future
PURCHASING POWER PARITY THEORY
• Founded by Swedish economist Gustav Cassel in 1918.

• Meaning : According to this theory ,the price levels and the

changes in these price levels in different countries determine
the exchanges rates of these countries currencies.
• The basic principle of this theory is that the exchange rates
between various currencies reflect the purchasing power of
these currencies .This theory is based law of one price.
• Absolute form of PPP • Relative form of PPP

• If the law of one price were to • This theory describes the link between the

hold good for each and every changes in spot exchange rate and in the

price levels over a period of time.

commodity then the theory is
• According to this theory ,changes in spot
termed as Absolute form of PPP
rates over a period of time reflect the
Theory.
changes in the price level over the same
• This theory describes the link period in the concerned economies.
between the spot exchange • This theory relaxes three assumptions of PPP
rate and price levels at a ie Absences of transportation

particular point of time cost ,transaction costs and tariffs.

 FOREIGN EXCHNAGE EXPOSURE
• It is the risk associated with activities that involved a
global firm in currencies other than home currencies.
Foreign exchange exposure

Translation exposure (accounting

exposure) Economic exposure
Transaction exposure It is because the exposure is due to the directly impacts the value of a firm. That
translation of books of accounts into the means, the value of the firm is
(risk in transactions)
home currency influenced by the foreign exchange.
e.g. - If you have bought goods from a
foreign country and payables are in
foreign currency to be paid after 3
months, you may end up paying much
higher on the due date as currency
value may increase.
 RECENT TRENDS IN GLOBAL FINANCIAL MARKET
EMERGENCE OF
DEREGULATION CROSS BORDER RISING
MNC’S FROM
OF FINANCIAL M&A POPULARITY OF
EMERGING
MARKETS ACTIVITIES EURO MARKETS
ECONOMIES
In 1950 Euro dollar markets emerged
Internationalization of money and Rise in FDI level resulted from cross and now expanded to include other
capital markets border mergers and acquisitions currencies Emergence of MNC’s from emerging
economies.

Also termed as Euro markets.

Acquisition of ABN-AMRO by
US and most of Europe have almost consortium of Royal Bank of
free financial market Scotland, Fortis and Santander is the
largest deal in banking history
In 2006 it was observed that among
Market consists of banks outside the
100 MNC’s of the world 22 were
country from where the currencies
headquartered at developing
originates.
countries

Singapore and Hong Kong emerged Most of these transactions were debt
as key players financed
Euro banks are free from any
regulation and become a popular
choice for MNC’s for financial plans

MNC’s from the developing and

There was an increase till 2007 and transitional economies have started
This led to creation of world wide They have the ability to expand playing a significant role today
decreased from 2008 due to
banking structure stock of money and credit outside
financial crisis.
the control of national authorities