International Financial Management

1. MBA - Semester III
International Finance & Forex Management
Module – 1
(International Financial
Environment)

2. Syllabus – Module I
• Finance function in global business scenario;
• International Monetary System;
• International Financial Markets - equity, bond,
Eurocurrency market, Currency basket;
• Currency convertibility – on capital account and
current account;
• Balance of payments, balance of trade, current
account deficit, foreign exchange reserves;

3. Syllabus – Module I
• Bilateral and multilateral trade and agreements
relating to financial transactions,
• Sovereign rating,
• Flow of funds internationally through FDI, FII and
FDI in Retail and Govt. Policies regarding FII & FDI
• Integration of global developments with the
changing business environment in India.

4. Finance function in global business scenario;
• IFM is concerned with all Int’l Business related finance
functions
• It involves dealing with Int’l Financial system as against
Domestic Financial System
• There are three modes of IB –
• Multilateral Trade,
• Bilateral Trade – Counter Trade, Buy Back Arrangement
• Contractual Entry modes like licensing, franchising,
management contracts, and turn key projects

5. Finance function in global business scenario
• Cross – border investment
• Exchange of currency, Exchange Rate related
considerations
• Exchange Rate Risk – Arbitrage, Hedging and Speculation
• International Capital budgeting –
• FDI -involving long term international capital budgeting
decisions

6. Finance function in global business scenario
• Raising of Fund and managing risk
• Effective Cost of Funds
• Debt - equity decision
• Desired Currency, Rate and their swapping to manage
risk
• Optimizing current assets and current liabilities and
managing liquidity and profitability trade off
• Int’l Tax Strategy - Transfer pricing to siphon off pre-tax
profit from high tax to low tax country
• Balance of Payment and External indebtedness

7. Finance function in global business scenario
• Foreign Exchange Market including derivatives
• Exchange Rates – Determination and Forecasting
• Exchange Rate – Exposure and Risk Management
• International Monetary System
• Investment decisions of FDI and FPI
• International Financial Markets including Euro currency
market
• International Accounting and Taxation Strategy
• Balance of Payment
• International indebtedness and its management

8. International Monetary System
• International monetary systems are sets of internationally
agreed rules, conventions and supporting institutions, that
facilitate international trade, payments, cross border
investment, liquidity and, generally, allocation of
capital among nation states.
• International monetary system refers to the system
prevailing in global foreign exchange markets through
which international trade and capital movement are
financed and exchange rates are determined.

9. International Monetary System
• The International Monetary System is part of the
institutional framework that binds global economies.
• Such a system permits producers to specialize in those
goods in which they have a comparative advantage, and to
seek profitable investment opportunities on a global basis.
• It enables entrepreneurs to raise resources and capital from
where it is most cheaply available, produce where it is most
convenient and economical to do so, and sell in markets
where they command the highest price.
• In other words, they promote globalization, per se.

10. International Monetary System
• It also provides a set of procedures, mechanisms,
processes, institutions to establish the rate at which
exchange of one currency is determined with respect to
any other currency.
• The whole story of global monetary and financial system
revolves around 'Exchange Rate' i.e. the rate at which
currency is exchanged among different countries for
settlement of payments arising from trading of goods and
services.

11. International Monetary System
• It should promote flow of international trade and
investment according to comparative advantage.
• It should ensure stability in foreign exchange and should be
stable.
• It should promote Balance of Payments adjustments to
prevent disruptions associated with temporary or chronic
imbalances.
• It should provide countries with sufficient liquidity to
finance temporary balance of payments deficits.
• It should allow member countries to pursue independent
monetary and fiscal policies.

12. International Monetary System –
Exchange Rate Regimes
• Fixed Exchange Rate
• Flexible Exchange Rate
• Floating Exchange Rate
• Managed Float

13. International Monetary System – Brief History
• Classical Gold Standard (1816 – 1914) - Gold Species
Standard, Bullion Standard and Gold Exchange Standard.
• At the end of the 19th century , GBP was the reserve
currency of major part of the world
• Interwar Period (1918 – 1939) – World War I and the period
that followed saw the fall of the Gold Standard.
• Great Depression of 1930s saw the break down of IMS

14. International Monetary System – Brief History
• Bretton Woods System (1944 – 1971) – Reformed version of
Gold Standard where currencies were linked with USD
which was the single largest holder of gold and had its
currency linked to gold
• USD emerged as the strongest currency and the reserve
currency of the world .
• Fixed Parity Exchange Rate emerged during this period.
• IMF was created to monitor the implementation of Bretton
Woods System.

15. International Monetary System – Brief History
• Present International Monetary System - 1971 onwards -
• Dollar was delinked with gold as its convertibility was not
assured on account of enormous rise in its stock
domestically and globally.
• Different versions of exchange rate mechanism came to be
adopted across the globe in different currency areas, zones
and blocks of countries, like Euro Zone.
• Fixed, Floating, Pegged Exchange rate systems emerged as
per the suitability of nation states.

16. International Financial Markets -
Eurocurrency market, Euro Bond, Foreign
Bond, Euro Equity,
• Eurocurrency is currency held on deposit outside its home
market, i.e., held in banks located outside of the country
which issues the currency. For example, a US dollar
denominated deposit in a Singapore bank is Eurocurrency,
or more specifically Eurodollar deposit.
• A Eurobond is denominated in a currency other than the
home currency of the country or market in which it is
issued. e.g., USD denominated bonds issued in Venezuela,
and bought and sold

17. Foreign Bond, Euro equity
• Foreign Bond - Issued / Sold outside borrower’s country and
denominated in currency of the country in which it is sold
(e.g., Yen-denominated bond issued by German company
in Japan’s bond market).
• A euro equity initial public offering (IPO), also called a euro
equity issue, is an IPO that is sold to investors in more than
one national market, rather than just in the country where
the company is domiciled. It Consists of all stocks bought
and sold outside the issuer’s home country.

18. Currency basket
• The portfolio of specific amounts of multiple currencies the
value of which is used as the basis for setting the market
value or exchange–rate of another currency.
• It is also referred to as a currency cocktail.
• A portfolio of several foreign currencies with different
weightings. For example, one may construct a currency
basket with 40% Euro, 35% USD and 25% GBP.
• The weightings determine the basket value as expressed in
any one currency of the basket, say USD.
• This basket value serves as the bench mark value for
equivalent amount of another (domestic) currency, and the
exchange rate is arrived at.

19. Currency Convertibility
Currency convertibility is the relative ease with which a
country's currency can be converted into another currency.
Currency convertibility is extremely important for International
Commerce.
When a currency is inconvertible, it poses a risk and barrier to
trade with foreigners who need the domestic currency for
transactions.

20. Why does anyone need to
convert currency??
To buy foreign goods and services
(Current Account Transactions)
To make investments abroad
(Capital Account Transactions)

21. Capital Account Transaction
Any transaction that alters the overseas asset or liability
position of a resident – e.g.,
• Investing abroad – Shares, debentures, MF’s
• Opening a bank account
• Buying real estate – commercial or residential
• Acquiring business or personal assets
• Lending overseas
•Autonomous Capital Flows
•Accommodating Capital Transactions

22. Current Account Transaction
Transaction that are NOT capital account transactions are
current account transactions – e.g.,
Buying and Selling Goods – (Visible Trade or Trade in
Merchandise)
Buying and Selling Services – (Invisible Trade)
Inward Receipts / Remittances - unrequited
Outward Remittances – unrequited
What is Trade Deficit
What is Current Account Deficit

23. Forex Reserves
Objectives of Holding Forex Reserves –
Meeting Current Account Deficit
Maintaining Exchange Rate Stability

24. Forex Reserves – Adequacy and Quality
Adequacy is judged in terms of
the exchange rate regime adopted by the country,
the extent of openness of the economy,
the size of the external sector in a country's GDP and
the nature of markets operating in the country
As a benchmark, import cover of 6-9 months is treated as
adequate. India holds around 11-12 months cover.
Quality is judged by the ratio of volatile capital flows including
short-term debt

25. Forex Reserves of some major economies
(in Mn USD)
1. China - 3,110,623 - May 2018
2. Japan - 1,256,018 - April 2018
3. Switzerland - 800,389 - May 2018
4. Saudi Arabia - 488,900 - December 2017
5. Russia - 460,300 - 13 July 2018
6. Taiwan - 458,500 - July 2018
7. Hong Kong - 431,900 - June 2018
8. South Korea - 402,400 - July 2018
9. India - 399,282 - 14 Sep 2018
10. Brazil - 379,444 July 2018

26. Sovereign rating
• Rating of the country reflecting on its ability to repay its
debts.
• S & P - BBB- ; Outlook Stable
• Moody’s Baa2; Outlook Stable
• CARE, FITCH, CRISIL, CARE
• Determines the inflow and outflow of FDI / FPI
• Depends on Macroeconomic variables like CAD, Inflation,
Fiscal Deficit, Forex Reserves, Rate of Economic Growth, etc.
• Rating and Outlook
• Investment and Non-Investment Grade

27. Bilateral and multilateral agreements relating
to financial transactions,
• Trade agreements are either bilateral, involving two
countries, or multilateral.
• Bilateral Trade is the exchange of goods between two
countries.
• Bilateral trade agreements give preference to certain
countries in commercial relationships, facilitating trade and
investment between the home country and the foreign
country by reducing or eliminating tariffs, import quotas,
export restraints and other trade barriers

28. Bilateral and multilateral agreements
• A multilateral trade agreement involves three or more
countries who wish to regulate trade between the nations
without discrimination.
• They are usually intended to lower trade barriers between
participating countries and, as a consequence, increase the
degree of economic integration between the participants.
• Multilateral trade agreements are considered the most
effective way of liberalizing trade in an interdependent
global economy.

29. Bilateral and multilateral agreements
• While some believe that bilateral free trade agreements are
a first step towards multilateral free trade, others point out
that bilateral trade agreements are discriminatory and lead
to fragmentation of the world trade system and decline of
the multilateral free trade.
• it was only after World War II that nations recognized the
need for a set of rules with the objective of securing market
access for post-war recovering economies.
• The first such set of rules came in 1947 in the form of the
General Agreement on Tariffs and Trade (GATT).
• GATT was replaced in 1995 by the World Trade
Organization, which has more than 150 members

30. Flow of funds internationally through FDI, FPI
and Govt. Policies
• Foreign Direct Investment (FDI) and Portfolio
Investment (FPI) are two of the most common
routes for investors to invest in an overseas
economy. FDI implies investment by foreign
investors directly in the productive assets of
another nation.
• FPI means investing in financial assets, such as
stocks and bonds of entities located in another
country.

31. Flow of funds internationally through FDI, FPI
• FDI investors perforce have to take a long-term
approach to their investments since it can take
years from the planning stage to project
implementation.
• On the other hand, FPI investors may profess to be
in for the long haul but often have a much
shorter investment horizon, especially when the
local economy encounters some turbulence.

32. Flow of funds internationally through FDI, FPI
• FDI investors can not easily liquidate their
assets and depart from a nation, since such assets
may be very large and quite illiquid.
• FPI investors can exit a nation literally with a few
mouse clicks, as financial assets are highly liquid
and widely traded. Nations with a high level of FPI
can encounter heightened market volatility and
currency turmoil during times of uncertainty.

33. Integration of global developments with the
changing business environment in India.
• Price Waterhouse Coopers (PwC) has identified five
megatrends that are changing the business environment.
These megatrends will influence consumer preferences and
regulation.
• They will throw up new challenges, risks and opportunities.
Companies will have to see how they can innovate, reinvent
and remain relevant

34. Changing business environment
• Growing Urban Population –
• The United Nations predicts that urban populations will
grow by 72% in 2050. This growth will mainly happen in
African and Asian countries and the rural population will
fuel this growth.
• There will be a greater demand for resources to build
infrastructure, educate residence, provide security and
promote employment opportunities.

35. Changing business environment
• Global Warming –
• We are likely to see an increase in regulation directed
towards conservation and sustainability.
• We should also see an increase in conflicts around the
world as access to resources is decreased.

36. Changing business environment
• Demographic Changes –
• Populations are growing older in developed countries while
other countries are experiencing an increase in their
overall growth rate.
• This will cause shortage of skilled manpower, challenges of
acquiring and retaining talent and higher provisioning for
social security leading to changes in business models.

37. Changing business environment
• Emerging Markets Gain Power –
• Now developing countries, in particular “BRIC” countries,
are gaining more influence due to increases in population,
exports, and innovation.
• This shift in economic power may create more competition
on a global scale while reducing the influence of Western
markets.

38. Changing business environment
• Advances in Technology
• New technological developments are creating totally new
industries. These breakthroughs have come from advances
in nanotechnology, research and development, and mobile
technology.
• There will be fewer barriers for virtual businesses, thus
creating more competition; and the ability to leverage and
use this technology will be a necessity instead of just an
advantage.
• There will emerge the need to promote ease of doing
business and multi-directional reforms to remain relevant
and competitive.

39. Foreign Exchange
• Section 2(n) of FEMA -
• Foreign Exchange means Foreign Currency, and also
includes -
• Deposits, Credits and balances payable in any foreign
currency
• Drafts, TCs, LCs, BEs expressed or drawn in Indian Currency
but payable in foreign currency
• Drafts, TCs, LCs, BEs drawn by banks, institutions or persons
outside India but payable in Indian currency

40. Foreign Exchange & Characteristics
• Foreign Currency means currency notes, postal notes, postal order,
money order, cheque, draft, LC, TC, BE, PN, Credit Card and such other
instruments as may be notified by RBI
• Currency Notes are coins and bank notes
• Scarcity Character
• Commodity Character
• No exact location of market
• An OTC Market
• Twenty - four hour market. (London, NY, Tokyo, Zurich, Frankfurt)
• Very Volatile – Rates fluctuate almost every 4 seconds (21,600 times a
day)
• Major players are MNCs, commercial banks, exchange brokers, central
banks

41. Foreign Exchange & Characteristics
• ADs are market makers
• Five day operation
• Two way quotes – “Buy Low – Sell High”
• Market for Foreign Exchange
• Merchant Market
• Inter-bank Market
• International Market
• The latter two are resorted to for Cover Deals, Finer rates,
and Bench mark Rates

42. Foreign Exchange & Characteristics
• Free dealing (buying and selling) of foreign exchange among
public not permitted
• RBI appoints authorized Persons to deal in foreign exchange
(Sec 10)
• Authorized Persons include
• Authorized Dealers Cat I
• Authorized Dealers Cat II ( non trade related Current
Account Transactions)
• Authorized Dealers Cat III
• FFMCs
• Compliance with directives, disclosures and penalties
imposed by RBI (Sec 11)

43. Foreign Exchange Quotes
• The rates at which an AD buys and sells foreign exchange is
called exchange rate
• It is expressed as a two way quote
• A two way quote is one that expresses both the buying and
selling rates
• It may be Indirect / Foreign Currency rate
• INR 100 = USD 2.3780 / 2.4280
• It may be Direct / Home Currency rate
• USD 1 = INR 46.20 / 46.70
• Buy Low Sell High
• Also called Bid / Offer rate
• Basis Point Spread

44. Spot and Forward
• Ready / Value Today / Outright Cash Transaction - Exchange
of currencies takes place on the same date
• TOM – Exchange of currencies takes place on the next
working day
• SPOT – Exchange of currencies takes place by the close of
working hours on the second working day after the date of
transaction
• All above are known as varieties of SPOT Transactions
• When exchange of currencies is agreed to take place
anytime subsequent to the second working day after the
deal, it is called Forward Transaction

45. Quoting Merchant Rates from
Inter-bank market quotations
• Inter-bank market quotations are for wholesale deals. They
are finer rates allowing for smaller spreads and are
expressed up to four decimal places
• Inter-bank spot and forward rates form the basis for
Merchant spot and forward rate quotations
• Forward rates (both buying and selling) are either at
premium to or at a discount on the spot rates
• At Premium means that foreign currency is costlier on a
future date as compared to spot rates
• At Discount means that foreign currency is cheaper on a
future date as compared to spot rates

46. Spot and Forward – Card, Merchant and Fine Rates
• Card Rate – These rates are buying and selling rates
computed by AD at the start of the business for small value
transactions, e.g., up to an amount equivalent to USD 5000
• Merchant Rates – These are rates for relatively higher value
transactions, actually quoted to customer based on ongoing
market rates, when he approaches AD
• Fine Rate – Depending upon the connections of the party,
the bank quotes competitive rates with thinner spreads –
Buying a little higher and Selling a little Lower

47. Cross Rate
• Cross Rate – Rate of a foreign currency given in terms of
another foreign currency, e.g.,
• If USD 1 = CAD 1.4045 / 4085 (Singapore)
• And USD 1 = INR 46.2000 / 7000 (Inter bank)
• Against sale of CAD, USD will be bought in Singapore
market at market selling rate (1.4085)
• USD so purchased will be converted to INR at the inter bank
buying rate –
• CAD1.4085 = INR46.20
• Cross Rate for CAD will be INR 46.20 / 1.4085

48. • Premium and Discount
• The difference between forward and spot rates, denoting
premium or discount, is called forward margin
• Interest rate is one of the prime determinants of forward
premium or discount
• Forward margins expressed in ascending order denote
Premium
• Forward margins expressed in descending order denote
discount

49. Transaction, Translation and Operating Risk
• A transaction arranged in a foreign currency involves the
risk of change in the value of foreign currency before
the transaction is complete.
• If the Indian exporter has the receivable of $5,00,000 due
five months hence, but in the meanwhile the dollar
depreciates relative to the rupee, then the exporter will
suffer the cash loss.
• But however, in the case of a payable of the same amount,
the importer gains if the dollar depreciates relative to the
rupee.

50. Transaction, Translation and Operating Risk
• Translation exposure is the risk that a company's equities,
assets, liabilities or income will change in value as a result
of exchange rate changes.
• This occurs when a firm denominates a portion of its
equities, assets, liabilities or income in a foreign currency. It
is also known as "accounting exposure.”
• Accountants use various methods to insulate firms from
these types of risks, such as consolidation techniques for
the firm's financial statements and using the most
effective cost accounting evaluation procedures.
• In many cases, translation exposure is recorded in financial
statements as an exchange rate gain (or loss).

51. Transaction, Translation and Operating Risk
• Translation exposure is most evident in multinational
organizations, since a portion of their operations and assets
will be based in a foreign currency.
• This exposure normally materializes at the time of
translating the overseas exposure to domestic currency,
precisely on the date of the balance sheet
• In order to properly report the organization's financial
situation, the assets and liabilities for the whole company
need to be adjusted into the home currency.
• Translation risk can lead to what appears to be a financial
gain or loss that is not the result of a change in assets, but
change in the current value of the assets based on exchange
rate fluctuations.

52. Transaction, Translation and Operating Risk
• For example, should a company be in possession of a facility
located in Germany worth €1 million and the current dollar-
to-euro exchange rate is 1:1, then the property would be
reported as a $1 million asset. If the exchange rate changes,
and the dollar-to-euro ratio becomes 1:2, the asset would
be reported as having a value of $500,000. This would
appear as a $500,000 loss on financial statements, even
though the company is in possession of the exact same
asset it had before.
• A variety of mechanisms are in place that allow a company
to use hedging to lower the risk created by translation
exposure.
• One technique includes the purchasing of foreign currency,
while others involve the use of currency futures or currency
swaps.

53. Transaction, Translation and Operating Risk
• Operating Exposure refers to the extent to which the firm’s
future cash flows gets affected due to the change in the
foreign exchange rates along with the price changes.
• In other words, a risk that firm’s revenue will be adversely
affected due to the substantial change in the exchange rate
and the inflation rate is called as operating exposure.
• Transaction exposure, is specific to a particular transaction
of the firm,
• Operating Exposure implies macro level exposure wherein
not only the firm under concern gets affected but the whole
industry / economy observes the change with the change in
the exchange rates and the inflation rate.
• Thus, with operating exposure, the entire economy is
exposed to the foreign exchange risk.

54. Transaction, Translation and Operating Risk
• If the Indian exporter has the receivable of $5,00,000 due
five months hence, but in the meanwhile the dollar
depreciates relative to the rupee, then the exporter will
suffer the cash loss.
• But however, in the case of a payable of the same amount,
the importer gains if the dollar depreciates relative to the
rupee.

55. Swaps and Currency Swaps
• An agreement between two counter parties having matching
and opposite needs to exchange specific streams of payment
and receipts over an agreed period of time
• It is a derivative products for risk management
• Opposite and matching needs of the parties
• A Currency Swap involves two parties that exchange
a notional principal with one another in order to gain
exposure to a desired currency. Following the initial notional
exchange, periodic cash flows are exchanged in the
appropriate currency.
• Cross Currency Interest Rate Swap - Exchange of Fixed
Interest Cash flow in one currency against Floating Interest
Cash Flow in another currency

56. • Arbitrage, Hedging and Speculation
• Currency Swaps, Futures and Currency
Options