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INTERNATIONAL FINANCIAL MANAGEMENT (UNIT-1) Meaning and Relevance of IFM: 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 may be defined as management of financial operations of different international activities of an organization. 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. International Finance is an important part of financial economics. It mainly discusses the issues related with monetary interactions of at least two or more countries. International finance is concerned with subjects such as exchange rates of currencies, monetary systems of the world, foreign direct investment (FDI), and other important issues associated with international financial management. Like international trade and business, international finance exists due to the fact that economic activities of businesses, governments, and organizations get affected by the existence of nations. It is a known fact that countries often borrow and lend from each other. In such trades, many countries use their own currencies. Therefore, we must understand how the currencies compare with each other. Moreover, we should also have a good understanding of how these goods are paid for and what is the determining factor of the prices that the currencies trade at. Note − The World Bank, the International Finance Corporation (IFC), the International Monetary Fund (IMF), and the National Bureau of Economic Research (NBER) are some of the notable international finance organizations.

International Business: Globalization Overview International financial management is a growing field with significant implications for the economic relationship between countries, businesses, and the global economy as a whole. Globalization has made a tremendous impact throughout the world in past few years. The world has seen a tremendous increase in the global transactions and foreign trade in recent years. International financial activity requires active management practices and tools. International financial management combines the fields of international finance and financial management. International finance refers to the field of economics that involves exchange rates, foreign investment, and international trade. Financial management refers to a division of management responsible for both resource management and finance operations. International financial management concerns multinational corporations as whole entities and involves cross-disciplinary decision-making. International financial management is a holistic endeavor involving international financial planning, financial control, and financial decision-making. Multinational corporations rely on international financial management to achieve the goals of creating a competitive advantage in the global marketplace and maximizing shareholder profits. Traditional models of corporate financial management are changing as a result of new technological, business, and market environments. International financial managers now manipulate and combine unbundled financial products, such as futures, swaps, derivatives, etc, to meet the needs of individual clients. Common concerns for international financial managers include the following: Exchange rate fluctuations, forecasting efficiency, transactions exposure, long-term financing, direct foreign investment, futures and options, country risk, international working capital management, transfer pricing, and economic exposure. The Global Economy International financial management is growing in importance as international financial activity and global markets become increasingly common. Global markets are characterized by an increasing mobility in capital, research and design processes, production facilities, customers, and regulators. Global markets, created through socioeconomic changes, political revolutions, and new Internet and communication technology, have no national borders. The modern trend of globalization, and resulting shifts from centralized to market economies in much of the world, has created

opportunities for increased trade, investment, business partnerships, and access to once closed global markets. Economic environments around the world are changing due to the forces of globalization. Globalization is characterized by the permeability of traditional boundaries of nations, culture, and economic market. The fundamental economic forces and events influencing globalization around the world include the end of communism; the shift from an economy based on natural resources to one based on knowledge industries; demographic shifts; the development of a global economy; increased trade liberalization; and advances in communication technology. Business opportunities, including international investments and joint ventures, in the global economy are increasingly tied to trade pacts. In addition, business opportunities are resulting from privatization worldwide. Countries are privatizing many state-owned industries and allowing foreign investors to purchase pieces of them through joint ventures or local operations so that they can participate in these projects. Emerging markets, often occurring in countries experiencing political upheaval, will continue to increase in the expanding global market. Businesses, participating in the new global economy, will continue to seek out new manufacturing and sales opportunities in foreign markets and countries. Difference between MNC and TNC An international company is an organization that has business operations in several markets across the globe. A multinational corporation (MNC) is an organization that owns or controls production of goods or services in one or more countries other than their home country. A transnational corporation (TNC) is a commercial enterprise that operates substantial facilities, (invest in foreign operations) does business in more than one country and does not consider any particular country its national home. Features (characteristics) of MNC’s (i) Huge Assets and Turnover: Due to operations on a global basis, MNCs have huge physical and financial assets. This also results in huge turnover (sales) of MNCs. In fact, in terms of assets and turnover, many MNCs are bigger than national economies of several countries.

(ii) International operations through a Network of Branches: MNCs have production and marketing operations in several countries; operating through a network of branches, subsidiaries and affiliates in host countries. (iii) Unity of Control: MNCs are characterized by unity of control. MNCs control business activities of their branches in foreign countries through head office located in the home country. Managements of branches operate within the policy framework of the parent corporation. (iv) Mighty Economic Power: MNCs are powerful economic entities. They keep on adding to their economic power through constant mergers and acquisitions of companies, in host countries. (v) Advanced and Sophisticated Technology: Generally, a MNC has at its command advanced and sophisticated technology. It employs capital intensive technology in manufacturing and marketing. (vi) Professional Management: A MNC employs professionally trained managers to handle huge funds, advanced technology and international business operations. (vii) Aggressive Advertising and Marketing: MNCs spend huge sums of money on advertising and marketing to secure international business. This is, perhaps, the biggest strategy of success of MNCs. Because of this strategy, they are able to sell whatever products/services, they produce/generate. (viii) Better Quality of Products: A MNC has to compete on the world level. It, therefore, has to pay special attention to the quality of its products.

Advantages of MNCs (i) Employment Generation: MNCs create large scale employment opportunities in host countries. This is a big advantage of MNCs for countries; where there is a lot of unemployment. (ii) Automatic Inflow of Foreign Capital: MNCs bring in much needed capital for the rapid development of developing countries. In fact, with the entry of MNCs, inflow of foreign capital is automatic. As a result of the entry of MNCs, India e.g. has attracted foreign investment with several million dollars. (iii) Proper Use of Idle Resources: Because of their advanced technical knowledge, MNCs are in a position to properly utilise idle physical and human resources of the host country. This results in an increase in the National Income of the host country. (iv) Improvement in Balance of Payment Position: MNCs help the host countries to increase their exports. As such, they help the host country to improve upon its Balance of Payment position. (vi) Technical Development: MNCs carry the advantages of technical development 10 host countries. In fact, MNCs are a vehicle for transference of technical development from one country to another. Because of MNCs poor host countries also begin to develop technically. (vii) Managerial Development: MNCs employ latest management techniques. People employed by MNCs do a lot of research in management. In a way, they help to professionalize management along latest lines of management theory and practice. This leads to managerial development in host countries.

(viii) End of Local Monopolies: The entry of MNCs leads to competition in the host countries. Local monopolies of host countries either start improving their products or reduce their prices. Thus MNCs put an end to exploitative practices of local monopolists. As a matter of fact, MNCs compel domestic companies to improve their efficiency and quality. (ix) Improvement in Standard of Living: By providing super quality products and services, MNCs help to improve the standard of living of people of host countries. (x) Promotion of international brotherhood and culture: MNCs integrate economies of various nations with the world economy. Through their international dealings, MNCs promote international brotherhood and culture; and pave way for world peace and prosperity. Limitations of MNC’s (i) Danger for Domestic Industries: MNCs, because of their vast economic power, pose a danger to domestic industries; which are still in the process of development. Domestic industries cannot face challenges posed by MNCs. Many domestic industries have to wind up, as a result of threat from MNCs. Thus MNCs give a setback to the economic growth of host countries. (ii) Repatriation of Profits: (Repatriation of profits means sending profits to their country). MNCs earn huge profits. Repatriation of profits by MNCs adversely affects the foreign exchange reserves of the host country; which means that a large amount of foreign exchange goes out of the host country. (iii) No Benefit to Poor People: MNCs produce only those things, which are used by the rich. Therefore, poor people of host countries do not get, generally, any benefit, out of MNCs.

(iv) Danger to Independence: Initially MNCs help the Government of the host country, in a number of ways; and then gradually start interfering in the political affairs of the host country. There is, then, an implicit danger to the independence of the host country, in the long-run. (v) Disregard of the National Interests of the Host Country: MNCs invest in most profitable sectors; and disregard the national goals and priorities of the host country. They do not care for the development of backward regions; and never care to solve chronic problems of the host country like unemployment and poverty. (vi) Misuse of Mighty Status: MNCs are powerful economic entities. They can afford to bear losses for a long while, in the hope of earning huge profits, once they have ended local competition and achieved monopoly. This may be the dirty strategy of MNCs to wipe off local competitors from the host country. (vii) Careless Exploitation of Natural Resources: MNCs tend to use the natural resources of the host country carelessly. They cause rapid depletion of some of the non-renewable natural resources of the host country. In this way, MNCs cause a permanent damage to the economic development of the host country. (viii) Selfish Promotion of Alien Culture: MNCs tend to promote alien culture in host country to sell their products. They make people forget about their own cultural heritage. In India, e.g. MNCs have created a taste for synthetic food, soft drinks etc. This promotion of foreign culture by MNCs is injurious to the health of people also. (ix) Exploitation of People, in a Systematic Manner: MNCs join hands with big business houses of host country and emerge as powerful monopolies. This leads to concentration of economic power only in a few hands.

Gradually these monopolies make it their birth right to exploit poor people and enrich themselves at the cost of the poor working class. Importance of International Finance International finance plays a critical role in international trade and inter-economy exchange of goods and services. It is important for a number of reasons, the most notable ones are listed here − a) International finance is an important tool to find the exchange rates, compare inflation rates, get an idea about investing in international debt securities, ascertain the economic status of other countries and judge the foreign markets. b) Exchange rates are very important in international finance, as they let us determine the relative values of currencies. International finance helps in calculating these rates. c) Various economic factors help in making international investment decisions. Economic factors of economies help in determining whether or not investors’ money is safe with foreign debt securities. d) Utilizing IFRS is an important factor for many stages of international finance. Financial statements made by the countries that have adopted IFRS are similar. It helps many countries to follow similar reporting systems. e) IFRS system, which is a part of international finance, also helps in saving money by following the rules of reporting on a single accounting standard. f) International finance has grown in stature due to globalization. It helps understand the basics of all international organizations and keeps the balance intact among them. g) An international finance system maintains peace among the nations. Without a solid finance measure, all nations would work for their self-interest. International finance helps in keeping that issue at bay. h) International finance organizations, such as IMF, the World Bank, etc., provide a mediators’ role in managing international finance disputes. Characteristic features of IFM International Finance is a distinct field of study and certain features set it apart from other fields. Compared to domestic financial management, international finance has some important distinguishing features below.

a) Foreign exchange risk An understanding of foreign exchange risk is essential for managers and investors in the modern day environment of unforeseen changes in foreign exchange rates. 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. At present, the exchange rates among some major currencies such as the US dollar, British pound, Japanese yen and the euro fluctuate in a totally unpredictable manner. Exchange rates have fluctuated since the 1970s after the fixed exchange rates were abandoned. Exchange rate variation affect the profitability of firms and all firms must understand foreign exchange risks in order to anticipate increased competition from imports or to value increased opportunities for exports. b) Political risk Another risk that firms may encounter in international finance is 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. MNCs must assess the political risk not only in countries where it is currently doing business but also where it expects to establish subsidiaries. The extreme form of political risk is when the sovereign country changes the ‘rules of the game’ and the affected parties have no alternatives open to them. Thus, political risk associated with international operations is generally greater than that associated with domestic operations and is generally more complicated. c) 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 7 markets where cost of capital is the

lowest. In addition, firms can also gain from greater economies of scale when they operate on a global basis. d) Market imperfections The final feature of international finance that distinguishes it from domestic finance is that world markets today are highly imperfect. There are profound differences among nations’ laws, tax systems, business practices and general cultural environments. Imperfections in the world financial markets tend to restrict the extent to which investors can diversify their portfolio. Though there are risks and costs in coping with these market imperfections, they also offer managers of international firm’s abundant opportunities. Nature and scope of International Financial Management: It has already been mentioned that IFM is concerned with the financial aspects of international business. In other words, international financial management deals with the financial decisions taken in the area of international business. It helps in taking the correct financial decisions so that the maximum gain may be derived from international business. The nature and scope of IFM are: 1. Mode of International Business: - Mode of international business is:  Foreign Trade: - The oldest form of international business is foreign trade. A firm imports its necessary inputs from the cheapest source, while it exports its output to different countries in order to earn maximum Foreign exchange. In this case, no overseas manufacturing is involved.  Licensing: - Another mode of international business that is licensing. When a firm lacks capital and detailed knowledge about a foreign market, it allows its technology, patent, trademark and other proprietary advantages to be used for a fee by licensee or technology importing firm.  Management contracting: - The third mode is known as management contracts. In this mode, the company sells abroad a particular resource, like management skills. The contract is meant for a given number of years during which the seller of management skills manage affairs of the company located in the host country for a specific fee.  Joint Venture: - Joint venture are the forth mode. They represent a partnership agreement which the venture is owned jointly by the international company and

a company of the host...