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INTERNATIONAL FINANCIAL

ENVIRONMENTMULTINATIONAL CORPORATION (MNC)

FOREIGN EXCHANGE MARKETS

Dividend remittance and financing

Exporting & importing Investing financing

Product markets subsidiaries International

financial Market

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The importance of multinational corporations andthe globalization of production are now wellrecognize. Multinational Corporations (MNC) havebecome central actors of the world economy and inlinking foreign Direct investment, trade, technologyand Finance, they are a driving force of economicgrowth. Since the world is reduced to an electronicvillage and Global Finance has become a realitytherefore in a contemporary global financial

corporation capital is one of the most fungibleassets to cross national boundaries. Thedeterminants of the way in which transnationalcorporation acquire, organize and manage thoseassets is of critical importance, not only to the

success of those corporations, but also to thedevelopment and industrial restructuring of nationstates. The task of an international FinancialManager is to make the best possible tacticaldecision that the market has to offer on liabilities

within the strategic funding constraints.

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1. Investment decision

2. Financing decision and

3. Asset management decisions

Scope of International Financial Management

1. Current Asset management2. Managing forex risks

3. International taxation

4. International capital under taking

5. Financing decision6. International accounting

7. Financing foreign trade

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1. Current Asset Management constitutes of :

a. Cash Management

b. Accounts receivable managementc. Inventory Management

a. Cash Management aims at

- minimizing cash balance

b. Accounts receivable management

- aims at management of creditors andcollection of amount receivable.

c. Inventory Management- Refers to the management of supplies, raw

material, works in progress, finishedgoods.

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2. Managing Foreign exchange risk

Multinational companies face three types

of risks.a. Transaction exposure : occurs when a

company faces a huge loss / profit in asingle shot due to forex fluctuations.

b. Translation exposes : Occurred whenstatement of account of host countryfigures are converted into home countrycurrency and converted into homecountry currency and profits many turninto losses because of sudden changes inthe currency rates.

c. Economic exposure : Occurs becauseof adverse economic environment in hostcountry. The company may face the risk

of losing the forecasted earning / profits.

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Techniques to over come the risks :

Forwards and derivatives futures, optionsswaps.

3. International taxation

Has a significant effect on

- making foreign investments

- Managing exchange risks

- Planning capital structure

- Managing flow of fundsThe problems here are

- Double taxation and transfer pricing

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4. International capital budgeting

The steps involved in international capital

budgeting are.- Estimating future cash in flows

- Discounting future in flows into present value

- Evaluating the profitability and selection ofbest alternative.

5. Financing decision

Involved decision regarding the

- Capital structure of the host county subsidiary.- Sources of financing the subsidiary

(debt / equity)

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6. International accounting

Firms engaged in international business face two

specific accounting problem.- Accounting transactions in foreign currencies.

- Translating the reported operations of foreignsubsidiaries into currency of the parent firm forconsolidating financial statement.

7. Financing foreign tradeIt foreign affiliate requires financing through longterm funds and short term funds. The key issueswith respect to financing foreign operations are

- Parent companys stake in equity- Optimal capital structure

- Sources of funds

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ROLE OF INTERNATIONAL FINANCIAL

MANAGER

The Chief tasks of the International Financial Manager aresummarized as under :-

1. Forecasting the Financial Environment prices, Inflation rates,Interest rates and exchange rates.

2. Management of Assets from cash management to

international cash budgeting, at home and abroad, in domesticand foreign currencies.

3. Management of liabilities borrowing relationship anddecisions, in domestic and foreign currencies, markets, shortterm and long term.

4. Exchange risk management measuring the effect ofexchange rate changes on balance sheets, income, and cashflows, and managing these risks.

5. Performance evaluation and control accounting for outsiders,tax authorities and for management and doing so acrosscountries and currencies without distortion.

Sounds like Herculean agenda ? Yes,

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Economic Frame work of international

financial Management

Disequilibrium conditions

Relative excess Money supplies1

Relative inflation rate

Rate of

Change of Relative interestExchange rate rates

Forward Premium

23

4

6

5

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IFM FINANCE FUNCTION

Finance Function of a firm can be divided into two sub functions

a) Control and Accounting b) Treasury

Treasurer Controller

Financial

Planning

Analysis

Cash Mgmt External

Reporting

Financial Mgmt

Accounting

Fundsacquisition

Fundsacquisition

Tax planning

Management

Budget

Planning

control

Budget

Planning

control

Risk

Management

Management

information

system

Accounts

receivable

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EXHIBIT 1

THE INTERNATIONAL FINANCIAL SYSTEM

Domestic Financial System International Financial System Domestic Financial

System

Country A Unique Elements Country B

Markets

Money market

Bond market

Equity market

Participant

Individual

Corporations

Governments

Intermediaries

Brokers

Markets

Money market

Bond market

Equity market

Participant

Individual

Corporations

Governments

Intermediaries

Brokers

ParticipantsDomestic participants from country A

Domestic participants from country B

International public financial or

Welfare organizations

Markets

Foreign exchange market

Eurocurrency market

Eurobond market

Forward and future markets

for foreign exchange

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EXCHANGE RATE SYSTEMS

The exchange rate is formally defined as the

value of one currency in terms of another. There

are different ways in which the exchange rates

can be determined. Exchange rates may befixed, floating, or with limited flexibility. Different

system have different methods of correcting the

disequilibrium between international payments

and receipts. Different mechanisms will bediscussed in subsequent sections.

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Fixed Exchange rate System

As the name suggests, under a fixed (or pegged)exchange rate system the value of a currency in terms ofanother is fixed. These rates are determined bygovernments or the Central Banks of the respectivecountries. The fixed exchange rates results from countriespegging their currencies to either some common

commodity or to some particular currency. There isgenerally some provision for correction of these fixedrates in case of a fundamental disequilibrium. Examples ofthis system are the gold standard and the Bretton WoodsSystem. The particular variation of the fixed rate systemare :

Fixed (or pegged) exchange rate systems include:

- Currency board system

- Target zone arrangement (also called currency block)

- Monetary union.

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CURRENCY BOARD SYSTEM

Under a currency board system, a country fixes the rate of itsdomestic currency in terms of a foreign currency, and its exchangerate in terms of other currencies depends on the exchange ratesbetween the other currencies and the currency to which the domesticcurrency is pegged. Due to pegging, the monetary policies andeconomic variables of the country of the reference currency arereflected in the domestic economy. If the fundamentals of the

domestic economy show a wide disparity with that of the referencecountrys, there is a pressure on the exchange rate to changeaccordingly. This may result in a run on the currency, thus forcing theauthorities to either change, or altogether abandon the peg. Toprevent such an event, the monetary policies are kept in lime with thatof the reference country by the central monetary authority, called thecurrency board. It commits to convert its domestic currency ondemand into the foreign anchor currency to an unlimited extent, at thefixed exchange rate. The currency board maintains reserves of theanchor currency up to 100% or more of the domestic currency incirculation. These reserves are generally held in the form of low-risk,interest bearing assets denominated in the anchor currency. Aninternationally accepted, relatively stable currency is generallyselected as the anchor currency.

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TARGET ZONE ARRANGEMENT

A group of countries sometimes gets together,and agrees to maintain the exchange ratesbetween their currencies within a certain bandaround fixed central exchange rates. This

system is called a target zone arrangement.Convergence of economic policies of theparticipating countries is a prerequisite for thesustenance of this system. An example of thissystem is the European Monetary System under

which twelve countries came together in 1979,and attempted to maintain the exchange rates oftheir currencies with other member countriescurrencies within a fixed band around the centralexchange rate.

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MONETARY UNION Monetary union is the next logical step of target

zone arrangement. Under this system, a group ofcountries agree to use a common currency, insteadof their individual currencies. This eliminates thevariability of exchange rates and the attendantinefficiencies completely. The economic variables ofthe member countries have to be quite proximatefor the system to be viable. An independent,Common Central Bank is set-up, which has the soleauthority to issue currency and to determine themonetary policy of the group as a whole. The

member countries lose the power to use economicvariables like interest rates to adjust theireconomies to the phase of economic cycle beingexperienced by them. As a result, the region as awhole experiences the same inflation rate. This is

the most extreme form of management of exchangerates.

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Floating Exchange Rate System

Under this system, the exchange rates between currencies arevariable. These rates are determined by the demand and supply forthe currencies in the international market. These, in turn, dependon the flow of money between the countries, which may either

result due to international trade in goods or services, or due topurely financial flows. Hence, in case of a deficit or surplus in theBalance of Payments (difference between the inflation rates,interest rates and economic growth of the countries are some of thefactors which result in such imbalances), the exchange rates getautomatically adjusted and this leads to a correction in theimbalance.

Floating exchange rates can be of two types : Free float andManaged float.

Floating exchange rates can be of two types : Free flat and Managedfloat.

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FREE FLOAT

The exchange rate is said to be freely floating whenits movements are totally determined by the market.There is no intervention at all either by thegovernment or by the Central Bank. The current andexpected future demand and supply of currencieschange on a day to day, and even a moment to moment basis ; as the market receives,analyzes and reacts to economic, political andsocial news. This, in turn, changes the equilibrium inthe currency market and the exchange rate isdetermined accordingly. As the reactions to eventsdo not follow a set pattern, the resultant movementsin the exchange rates turn out to be quite random.Hence, a lot of volatility is observed in the marketsfollowing a free float system. This system is alsoknown as the clean float.

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MANAGED FLOATThis management of exchange rates can take three forms :

i. The Central Bank may occasionally enter the market in orderto smoothen the transition from one rate to another, whileallowing the market to follow its own trend. The aim may be toavoid fluctuations which may not be in accordance with theunderlying economic fundamentals, and speculative attackson the currency.

ii. Some events are liable to have only a temporary effect on themarkets. In the second variation, intervention may take placeto prevent these short and medium-term effects, while lettingthe markets find their own equilibrium rates in the long-term, inaccordance with the fundamentals.

iii. In the third variation, though officially the exchange rate maybe floating, in reality the Central Bank may intervene regularlyin the currency market, thus unofficially keeping it fixed.