CENTRE CODE-00885

SUBJECT CODE & NAME

MF0015/ IB0010 & INTERNATIONAL FINANCIAL MANAGEMENT
Submitted by:

Nirmal Kaur
1411000397
MBA 3rd semester
Question 1 Discuss the goals of international financial management
Answer 1
Effective financial management is not limited to the application of the latest business
techniques or functioning more efficiently but includes maximization of wealth meaning
that it aims to offer profit to the shareholder, the owners of the businesses and to ensure
that they gain benefits from the business decisions that have been made. So, the goal of
international financial management is to increase the wealth of shareholders just like in
domestic financial management.
The goals are not only limited to just the shareholders, but also to the suppliers,
customers and employees. It is also understood that any goal cannot be achieved
without achieving the welfare of the shareholders. Increasing the price of the share
would mean maximizing shareholders wealth.
Though in many countries such as Canada, the United Kingdom, Australia and the
United States, it has been accepted that the primary goal of financial management is to
maximize the wealth of the shareholders; in other countries it is not as widely embraced.
In countries such as Germany and France, the shareholders are generally viewed as a
part of the stakeholders along with the customers, banks, suppliers and so on. In
European countries, the managers consider the most important goal to be the overall
welfare of the stakeholders of the firm. On the other hand, in Japan, many companies
come together to form a small number of business groups known as Keiretsu, including
companies such as Mitsui, Sumitomo and Mitsubishi which were formed due to
consolidation of family-owned business empires. The growth and the prosperity of their
Keiretsu is the most critical goal for the Japanese managers.
However, it doesnt mean that the maximization of shareholders wealth is just an
alternative but it is a goal that a company seeks to fulfill along with other goals. The
maximization of shareholders wealth is a long term goal. If a firm does not treat the
employees properly or produces merchandises of poor quality, it cannot be expected
that such firms will be able to maximize the shareholders wealth. Only those firms can
stay in business for a long term and provide opportunities for employment that efficiently
produces what is demanded from them.

However, in recent times, as capital markets are becoming more integrated and
liberalized, managers in countries such as France, Germany and Japan have started
paying serious attention to the maximization of the shareholders wealth. For instance, in
Germany, companies can now repurchase stocks, if necessary for the shareholders
benefit.

Question 2 In foreign exchange market many types of transactions take place.

Discuss the meaning and role of forward, future and options market.
Answer 2
Forward Market: In the forward market, contracts are made to buy and sell currencies
for future delivery, say, after a fortnight, one month two months, or three months. The
rate of exchange for the transaction is agreed upon on the very day the deal is finalized.
The forward rates with varying maturity are quoted in the newspapers and those rates
form the basis of the contract. Both the parties have to abide by the exchange rate
mentioned in the contract irrespective of whether the spot rate on the maturity date is
more or less than that of the forward rate. In other words, no party can back out of the
deal, even if changes in the future spot rate are not in his or her favour.
The value date in case of a forward contract lies definitely beyond the value date
applicable to a spot contract. If it is a one-month forward contract, the value date will be
the date in the next month corresponding to the spot value date. Suppose a currency is
purchased on 1 August, if it is a spot transaction, the currency will be delivered on 3
August.
But if it is a one-month forward contract, the value date will fall on 3 September. If the
value date falls on a holiday, the subsequent date will be the value date. If the value date
does not exist in the calendar, such as 29 February (if it is not a leap year) the value
date will fall on 28 February. Sometimes, the value date is structured to enable one of
the parties to the transaction to have the freedom to select a value date within the
prescribed period. This happens when the party does not know in advance the precise
date on which it would be able to deliver the currency; for instance, an exporter who sells
a foreign currency forward without knowing in advance the precise date of shipment.
Again, the maturity period of forward contract is normally for one month, two months,
three months, and so on but sometimes it may not be for the whole month and a fraction
of a month may also be involved. A forward contract with a maturity period of thirty-five
days is an opposite example. Naturally, in this case, the value date falls on a date
between two complete months. Such a contract is known as broken-date contract.
Future Market: The foreign exchange market involving forward contracts has a long
history but the market for currency futures has a comparatively recent origin. It came into
being in 1972 when the Chicago Mercentile Exchange has set up its international
monetary market division for trading of currency futures. Currency futures are traded
only in a limited number of currencies. A forward contract is finalized on telephone, etc.
meaning that it represents an over-the-counter market. But in case of currency futures,
brokers strike the deals sitting face to face under a trading roof, known as pits. The
brokers can trade for themselves as well as on behalf of the customers. When they trade
for themselves, they are called locals or floor traders. On the other hand, when the

brokers trade on behalf of their customers, they are known as commission brokers or
floor brokers.
When a trader has to enter a currency futures contract, he informs his agent who in turn
informs the commission broker at the stock exchange. The commission broker executes
the deal in the pit for a commission/fee. After the deal is executed, the commission
broker confirms the trade with the agent of the trader. There are different costs
associated with the transactions in the market for currency futures. The first is the
brokerage commission that is charged by the commission brokers and covers both the
opening and the reversing trade. The second is the floor trading and clearing fee
charged by the stock exchange and its associated clearing house. Normally, this fee is
included in the brokerage commission but when the locals trade for themselves, the fee
is quite exclusively found. The third is the delivery cost that is related to the delivery of
the currencies but since actual delivery of the currencies seldom takes place, such cost
is not common.
Option Market: The market for currency options is the other form of the derivatives
market representing large-scale sale and purchase of currencies. This form of market
possesses some distinguishing features and also the methods of operation are different.
There are three different types of option market. They are listed currency options market,
currency futures options market and over-the-counter options market.

Question 3 Thousands of years back the concept of bartering between parties

was prevalent, when the concept of money had not evolved.
Explain on counter trade with examples
Answer 3
Thousands of years ago, the concept of bartering between parties was prevalent, when
the concept of money had not evolved. A person could give say 100 bags of wheat and
get wood or coal, a certain quantity for cooking. These bartering contracts were between
individuals or small kingdoms. Bartering exists today also but at different level. For
example, Iran may give 100 million barrels of oil to France and get 5000 guns of certain
type in exchange. We can say that bartering is exchange of goods between parties as
per agreed terms without the use of money.
Today, most business is transacted with money as medium. Trading between countries
is through respective currencies using international exchange rate. Countertrade means
all types of foreign trade in which the sale of goods to another country is associated with
parallel purchase of some other goods from that country.
In countertrade, there is exchange of goods between two parties in different countries
under two separate contracts in money terms. Delivery and payment of the two contracts
are independent transactions. Countertrade deals are mostly negotiated and executed
either at government to government level or between organisations with approval of
respective governments. Countertrade takes many different forms as explained below:
(i) Barter: It is exchange of goods without the use of money. Typical examples
are:
(a) Oman exchange oil for air conditions with Taiwan
(b) Sri Lanka exchange fish for mobile handsets with Germany
(ii) Buy back: In this part, the payment of the price of contract is through supply
of related products. Typical examples are:

(a) A firm in China purchases plant & technology for manufacture of high
precision bearings from Germany, and the firm in Germany agrees to buy a part of
bearings produced by the plant in China.
(b) An Indian aerospace firm sets up production facility for manufacture of
executive jets under technical collaboration from an American firm who in turn agrees to
provide a part of worldwide business of overhauling of executive jets to the Indian firm.
(c) A firm establishes gas pipeline for another firm to transport gas and
produce electricity and in turn agrees to buy a portion of electric power for prolonged
period at predetermined terms.
(iii) Counter purchase: In such cases, there is direct purchase of items as
exchange deals. Typical examples are:
(a) A firm in US sold soft drinks to Russian counterpart and imported
vodka in exchange.
(b) Canada sold wheat to Indonesia in exchange for import of rubber.
(c) A German firm sold machine tools to a firm in Romania in exchange for
import of hosiery items.
Examples of countertrade are many and in a variety of forms. Though countertrade
exists to create win-win situation between parties involved, it has its own ills; typically
following issues are existing:
1. The exporting country sells high technology items at inflated prices and the
items which they import are disposed off to other countries at a discount, using a part of
high premium charged on their exports.
2. The middlemen in the countertrade agreements are usually shrewd traders
who exploit the political and social circumstances to obtain large gains for themselves.
3. The goods that are offered in countertrade are not the required items, because
the desirable items have already been exported. For example, if Switzerland sells high
precision machines to Brazil, it may like Brazilian coffee beans in exchange, but what it
may get is only leather goods.

Question 4 There are different techniques of exposure management. One is the

Managing Transaction Exposure and the other one is the managing operating
exposure
So you have to explain on both Managing Transaction Exposure and Managing
Operating Exposure.
Answer 4
Managing Transaction Exposure:
Transaction exposure calculates gains or losses which occur after the current financial
compulsions according to terms of reference are resolved. Taken that the deal would
lead to a future inflow or outflow of foreign currency cash, any unprecedented alterations
in rate of exchange amid the period in which transaction is entered and the time taken
for it to settle in cash would guide to a change in worth of net flow of cash in terms of the
home currency. For example a transaction exposure of an Indian company will be the
account receivable which is associated with a sale denominated in US dollars or the
compulsion of an account payable in Euro debt.

Presume an Indian firm sells goods with an open account to a German buyer for
1,800,000 payment of which is to be done in 2 months. The current exchange rate is `
50/, and the Indian seller expects to exchange the euros received for ` 90,000,000
when payment is received. If euro weakens to `45/ when payment is received, the
Indian seller will receive only `81,000,000, or some `9,000,000 less than anticipated.
Opposite will be the case should euro strengthen. Thus exposure is a chance of either
gain or loss.
Alternative 1: Invoice the German buyer in rupees; but the Indian firm might not have
obtained the sale in the first place.
Alternative 2: Invoice the German buyer in dollars; both the parties are exposed should
an unanticipated change in exchange rate between dollar and the respective home
currency.
Managing Operating Exposure:
Operating exposure is alternatively known as economic exposure. It evaluates the
changes that occur in the current value of the firm. The change in the current value may
be a result of the change that takes place in predicted operating cash flows on account
of fluctuations in exchange rates.
They are similar in that they both deal with future cash flows. They differ in terms of
which cash flows management considers. Transaction exposure deals with the predicted
cash flows for future that have already been contracted and hence accounted for. At the
same time, the operating exposure focuses on the predicted-but not yet contracted-cash
flows in future. These future cash flows may undergo changes in case of a major
fluctuation in the exchange rate, resulting in changes in the overall competitiveness at
international level.
Suppose an Indian MNC, such as Videocon, has sales in India, United States, China
and Europe and therefore, posts a continuing series of foreign currency receivables (and
payables). Sales and expenses that are already contracted for are traditional transaction
exposures. Sales that are highly probable based on the Videocons historical business
line and market share but have no legal basis yet are anticipated transaction exposures.
Let us extend the analysis of the firms exposure to exchange rate changes even further
into the future. The analysis of this longer term where exchange rate changes are
unpredictable and, therefore, unexpected is the goal of operating exposure analysis.
Broadly speaking, operating exposure and its implications are not limited to the
sensitivity and dependability of the future cash flows of a firm upon the unpredictable
fluctuations in foreign exchange rates. It is also directly affected by other chaif
macroeconomic variables. This phenomenon is often known as macroeconomic
uncertainty.
Some firms face operating exposure without even dealing in foreign exchange. Consider
an Indian perfume manufacturer who sources and sells only in the domestic market.
Since the firms product competes against imported perfumes (say from Paris) it is
subject to foreign exchange exposure. It faces severe competition when rupee gains
against other currencies (here, euro), lowering the prices of imported perfumes.
Suppose that an Indian manufacturer has contracted to sell 100 pairs of jeans per year
to Britain at `1200 per pair and to buy 200 yards of denim from Britain in this same
period for 2 per yard. Suppose that 2 yards of denim are required per pair and that the
labour cost for each pair is `400. Suppose that at the time of contracting the exchange
rate is S (`/) = 80 and the rupee is then devalued to S (`/) = 81. Suppose also that the
elasticity of demand for Indian jeans in Britain is -2 and that after the contract expires the
Indian manufacturer raises the price of jeans to `1205 per pair. What are the
gains/losses from the devaluation on the jeans sold and on the denim bought at the pre-

contracted prices? (i.e., what are the gains/losses from transaction exposure on
payables and receivables?) What are the gains/losses from the extra competitiveness of
Indian jeans, that is, from operating exposure?

Question 5 There is a country risk involved every time an MNC operates in a

different country.
Discuss the two approaches to country risk management.
Answer 5
There are two approaches to country risk management.
1. Defensive approach: In this approach, the company tries to protect its interest
by finding those aspects of the company that are beyond the reach of the host
government. This reduces the firms dependence on the host country and the
government of the host country. The important strategies in the functional areas of the
company are discussed as follows:
Financial strategies: To protect against the hostility of the host government, a
company can take the following steps:
Maximum utilization of debt instruments.
Company does not raise all the capital through a single source but a variety of
sources are used like host government, local banks and third parties.
Companies prefer to enter into joint venture with the host government.
The most successful example is that of Suzuki. It entered into a joint venture with the
Government of India to form Maruti Suzuki.
Company can obtain host countrys guarantees for investment.
They can minimize local retained earnings.
If possible, the company should use transfer pricing.
Management policies: To protect the information about the companys
functioning, the following steps have to be taken:
Minimize the role of host nationals at strategic points and limit locals to low and
junior levels.
Train and educate host country nationals to inculcate loyalty.
If the host countrys nationals are at key positions, try to replace them.
Logistics: Once the country risk has been assessed, it is necessary to:
Locate the crucial segment of the companys process outside the country but
near the country.
Concentrate on R&D in the home country, making the subsidiary dependent on
the parent company.
Balance the production of goods among several locations, thus reducing
dependence on a single location.
Marketing management: Companys marketing policies should follow the
following steps:
Control markets wherever and whenever possible.
Maintain control over distribution network including transportation of goods.
Maintain a strong single global trademark.
Government relations: The Company should assess its own strengths and
weaknesses and try to negotiate with the government to defend its interests.

2. Integrative approach: This approach aims at integrating the company with the
host economy to make it appear local. The important strategies adopted are as follows:
Financial strategies: The following strategies should be adopted for financing
the projects in a host country:
Raise equity from the host country and take credit from the local parties.
Establish joint ventures with locals and the government.
Ensure that internal pricing among subsidiaries and between headquarters and
subsidiaries is fair.
Management strategies: The following strategies are required to be adopted for
integrating the company with the host country:
Employ high percentage of locals in the organization
Ensure that the expatriate understood the host environment
Establish commitment among local employees
Operations management: The following steps are required to be undertaken:
Maximize localization in terms of sourcing, employment and research and
development.
Use local sub-contractors, distributors, professionals and transport system.
Marketing management: Marketing policies should:
Share markets with domestic players as collaborators.
Appoint local distributors and use local network
Maintain a strong single global trademark
Government relations: A company should develop good and cordial
relationships by:
Developing and maintaining channels of communication with members of
country elite
Being willing to negotiate agreements that are fair to host government
Providing expert opinion whenever asked for
Providing public services

Question 6 Write short note on:

a. American Depository Receipts (ADR)
b. Portfolio
Answer 6
a. American Depository Receipts (ADR): It represents ownership in the shares of
a non-US company and trades in the American stock markets. ADRs enable
American investors to buy shares in foreign company without any issue of crossborder and cross-currency transactions.
ADRs carry price in American dollar, pay dividend in the same currency and can
be traded like any other share of US-based companies. Each ADR is issued by a
US depository bank and can represent one share. The owner of ADR has the
right to obtain the foreign stock it represents, but US investors are more
interested in owning ADR as they can diversify their investments across the
globe. ADR falls within the regulatory framework of the US and requires
registration of the ADRs and the underlying shares with the SEC.
Features of ADRs: The following are the features of ADR:
ADR can be listed on American Stock Exchange.

 A single ADR can represent more than one share. One ADR can be two
shares or any fraction also.
The holder of the ADRs can get them converted into shares.
The holders of ADR have no right to vote in the company.
Types of ADRs: ADR facilities may be established as either unsponsored or
sponsored. The type of ADR programme employed depends on the
requirements of the issuer. It is broadly classified as follows:
Unsponsored ADR programme: This facility is created in response to a
combination of investor, broker-dealer and depository interest. It is initiated by a
third party. Depository is the principal initiator of a facility because it perceives US
investor interest in a particular foreign security and recognizes the potential
income that may be derived from a facility.
Sponsored ADR programme: This facility is established jointly by an
issuer and a depository. Sponsored ADR facilities are created in the same
manner as unsponsored facility except that the issuer of the deposited securities
enters into a deposit agreement with the depository and signs the registration
statement. The deposit agreement sets out the rights and responsibilities of the
issuer, the depository and the ADR holder. Like unsponsored ADR facilities,
sponsored ADR facilities usually involve the use of a foreign custodian to hold the
deposited securities.
b. Portfolio: Portfolio is the combination of assets so as to reduce the risk by
diversification.
There are two major types of risks that are as follows:
1. Systematic risk: It is also known as market risk. It is the risk common to all
securities and all companies. These risks cannot be diversified away and some
examples are interest rates, recessions and wars. Technically speaking, it is that
part of the total variability of return caused by external variables such as factors
arising out of market, nature of industry and the state of economy. These are the
uncontrollable factors thus the risk arising out of these is undiversifiable risk.
2. Unsystematic risk: It is also called as the specific risk that is specific to the
individual asset and can be diversified away as we increase the number of assets
in our portfolio. This risk is due to the known and controllable factors like internal
variables of the company. It is also known as diversifiable risk as we can reduce
it by adding or reducing the number of securities to the portfolio.
Portfolio policy selecting securities and markets: Portfolio return and risk
measured are specific to the currency of investment. The return on a portfolio is a
weighted sum of returns on the assets comprising the portfolio, the weights being the
initial value of the share or asset in the portfolio. The return on the assets has two
components:
1. Dividend, 2. Capital gain