International Financial Management

International Financial ManagementIntroductionThe main objective of international financial management is to maximise shareholder wealth.Adam Smith wrote in his famous title, Wealth of Nations that if a foreign country can supply us with a commodity Cheaper than we ourselves can make it, better buy it of them with some part of the produce of our own in which we have some advantage.Basic FunctionsAcquisition of funds (financing decision)This function involves generating funds from internal as well as external sources. The effort is to get funds at the lowest cost possible. Investment decisionIt is concerned with deployment of the acquired funds in a manner so as to maximize shareholder wealth. Other decisions relate to dividend payment, working capital and capital structure etc. In addition, risk management involves both financing and investment decision. Nature & ScopeFinance function of a multinational firm has two functions namely, treasury and control. The treasurer is responsible for financial planning analysisfund acquisitioninvestment financingcash managementinvestment decision and risk management Controller deals with the functions related to external reportingtax planning and managementmanagement information systemfinancial and management accountingbudget planning and control, and accounts receivables etc.Environment at International Levelthe knowledge of latest changes in forex rates instability in capital marketinterest rate fluctuationsmacro level chargesmicro level economic indicatorssavings rateconsumption patterninvestment behaviour of investorsexport and import trendsCompetitionbanking sector performanceinflationary trendsdemand and supply conditions etc. International financial management practitioners are required the knowledge in the following fields.International financial manager will involve the study ofexchange rate and currency marketstheory and practice of estimating future exchange ratevarious risks such as political/country risk, exchange rate risk and interest rate riskvarious risk management techniquescost of capital and capital budgeting in international contextworking capital managementbalance of payment, and international financial institutions etc.Features of International FinanceForeign exchange riskPolitical riskExpanded opportunity setsMarket imperfectionsForeign exchange riskIn 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 characterised 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.Political riskPolitical 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.For example, in 1992, Enron Development Corporation, a subsidiary of a Houston based Energy Company, signed a contract to build Indias longest power plant. Unfortunately, the project got cancelled in 1995 by the politicians in Maharashtra who argued that India did not require the power plant. The company had spent nearly $ 300 million on the project.Expanded Opportunity SetsWhen firms go global, they also tend to benefit from expanded opportunities which are available now.They can raise funds in capital markets where cost of capital is the lowest. The firms can also gain from greater economies of scale when they operate on a global basis.Market Imperfectionsdomestic finance is that world markets today are highly imperfectdifferences among nations laws, tax systems, business practices and general cultural environments

International Trade TheoriesTheory of MercantilismTheory of Absolute Cost AdvantageTheory of Comparative Cost AdvantageTheory of MercantilismThis theory is during the sixteenth to the three-fourths of the eighteenth centuries. It beliefs in nationalism and the welfare of the nation alone, planning and regulation of economic activities for achieving the national goals, restriction imports and promoting exports.It believed that the power of a nation lied in its wealth, which grew by acquiring gold from abroad. Cont Theory of MercantilismMercantilists failed to realize that simultaneous export promotion and import regulation are not possible in all countries, and the mere control of gold does not enhance the welfare of a people.Keeping the resources in the form of gold reduces the production of goods and services and, thereby, lowers welfare. It was rejected by Adam Smith and Ricardo by stressing the importance of individuals, and pointing out that their welfare was the welfare of the nation.Theory of Absolute Cost AdvantageThis theory was propounded by Adam Smith (1776), arguing that the countries gain from trading, if they specialise according to their production advantages. The pre-trade exchange ratio in Country I would be 2A=1B and in Country II IA=2B.

Cont 15If it is nearer to Country I domestic exchange ratio then trade would be more beneficial to Country II and vice versa.Assuming the international exchange ratio is established IA=IB.The terms of trade between the trading partners would depend upon their economic strength and the bargaining power.Theory of Absolute Cost AdvantageTheory of Comparative Cost AdvantageRicardo (1817), though adhering to the absolute cost advantage principle of Adam Smith, pointed out that cost advantage to both the trade partners was not a necessary condition for trade to occur.According to Ricardo, so long as the other country is not equally less productive in all lines of production, measurable in terms of opportunity cost of each commodity in the two countries, it will still be mutually gainful for them if they enter into trade.Cont In the example given, the opportunity cost of one unit of A in country I is 0.89 (80/90) unit of good B and in country II it is 1.2 (120/100) unit of good B. On the other hand, the opportunity cost of one unit of good B in country I is 1.125 (90/80)units of good A and 0.83 (100/120) unit of good A, in country II.

Theory of Comparative Cost AdvantageCont 18The opportunity cost of the two goods are different in both the countries and as long as this is the case, they will have comparative advantage in the production of either, good A or good B, and will gain from trade regardless of the fact that one of the trade partners may be possessing absolute cost advantage in both lines of production.Thus, country I has comparative advantage in good A as the opportunity cost of its production is lower in this country as compared to its opportunity cost in country II which has comparative advantage in the production of good B on the same reasoning.Theory of Comparative Cost AdvantageInternational Business MethodsLicensing Franchising Subsidiaries and Acquisitions Strategic AlliancesExporting