Master of business Administration 4 Sem

INTERNATIONAL FINANCIAL MANAGEMENT

MF0015

Q.1) Explain the goals of international financial management. Give complete explanation on
Gold Standard 1876-1913. List down the advantages and disadvantages of Gold Standard.
Ans:- 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 business 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 shareholder 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.
Gold Standard 1876-1913
Form the ancient times, gold has been used as a medium of exchange as it is durable,
portable and easily tradable. Increase in the trade activity during the free-trade period in the
19th century led to the need for a more formalizes system for setting business transactions.
This made gold desirable to be used as a standard were that each country would establish
the rate at which its currency could be converted to the weight of gold. Each countrys
government agreed to buy or sell gold at its own fixed rate of demand. This served as a
mechanism to preserve the value of each individual currency in terms of gold. Each country
had to maintain adequate reserve of gold in order to back its currencys value. There was a
limit to the rate at which any individual country could expand its supply of money. The
growth in the money was limited to the rate at which additional gold could be acquired by
official authorities.
Advantages of Gold Standard
1. Gold standard provides stable exchange rates, which were conducive for trade policy
because this eliminates another source of price instability.
2. An efficient operating gold standard exchange rate system ensures automatic
adjustment of balance payment problem through price changes.
3. This system imposes orthodoxy on fiscal policies and restricts governments from
resorting to indiscriminate spending.
 Disadvantages of Gold Standard
1. The burden of BOP adjustment shift to domestic variables which subordinate the
domestic economy to external economic factors.
2. There is always a problem of selecting an appropriate par value which reflects the
external and internal equilibrium.
3. Emergence of misaligned values might have encouraged speculations of sufficient
magnitude to effect exchange rate realignment.
4. The gold standard was dependent on an adequate supply and not excess supply of new
gold.
5. The mining process of gold involves huge cost is used as a reserve only. The same
purpose can be served by some other asset that has no cost.
6. There is unequal geographic distribution of gold throughout the world. The countries
which had greater gold reserves enjoyed greater strength.

Q.2) Give an introduction on capital account with its sub-categories. Discuss about capital
account convertibility.
Ans: - Capital Account
It is an accounting measure of the total domestic currency value of financial transactions
between domestic residents and the rest world over a period of time. This account consists
of loan, investments and other transfers of financial assets and the creation of liabilities. It
includes financial transactions associated with international trade as well as flows associated
with portfolio shifts involving the purchase of foreign stocks, bond and bank deposits. It
includes three categories: direct investment, Portfolio investment and other capital flow.
There are three sub-categories on capital account:
Direct investment: it occurs when the investor acquires shares of a company
acquires the entire firm or the establishment of new subsidiaries. FDI takes place
when the firms tend to take advantage of various market imperfections. Firms also
undertake FDI when the expected returns from foreign investment exceed the cost
of capital, allowing for foreign exchange and political risks.
Portfolio investment: this represents the sales and purchases of foreign financial
assets such as stocks and bonds that do not involve a transfer of management
control. A desire for return, safety and liquidity in investments is the same for
international and domestic portfolio investors. International portfolio investments
have seen boom in the recent years as the investors have become aware about the
risk diversification that increased returns from the foreign markets have also given a
boost to such category of investors.
Capital flows: it represents the claim with a maturity of less than one year. Such
claims include bank deposits, short-term loans, short-term securities, money market
investment etc. these investments are sensitive to both changes in relative interest
rates between countries and the anticipated change in the exchange rate.

Capital Account Convertibility

When free inflows and outflows are allowed abroad except for capital purposes like loans
and investments, it is referred to as Current Account Convertibility. This really means that
residents of a country can make or receive trade related payments for example dollars, for
 exporting goods and services. They can also pay dollars for import of goods and services to
make sundry remittances, access foreign currency for studying for studying abroad, or
undergoing medical treatments, gifts or for travel purpose. Current Account Convertibility in
India was established with the acceptance of the obligations under Article VIII of the IMFs
Articles of Agreement in August 1994.
The term capital account convertibility means relaxing control on capital account
transactions. For instance, it could mean quantitative restriction on the movement of
capital, a multiple exchange rate system suggestion different exchange rates for
commercial/financial transactions or explicit/implicit tax on international financial
transaction transactions for discouraging the flow of capital. Thus, CAC gives way to an
absence of quantitative taxes on capital account transactions or the presence of a market-
based exchange rate system.

Q.3) Explain the concept of swap. Write down its features and various types of interest rate
swap.
Ans: - Swap is an agreement between two or more parties to exchange sets of cash flows over a
period in future. The parties that agree to swap are known as counter parties. It is a
combination of a purchase with a simultaneous sale for equal amount but different dates.
Swaps are used by corporate houses and banks as innovating financing instrument that
decreases borrowing costs and increases control over other financial instruments. Financial
swap is a funding technique that permits a borrower to access one market and then
exchange the liability for another type of liability. The first swap contract was negotiated in
1981 between Deutsche Bank and an undisclosed counter party. The International Swap
Dealers association (ISDA) was formed in 1984 to speed up the growth in the swap market
by standardizing swap documentation. In 1985, ISDA published the standardized swap code.

Feature of swap
Swaps are contracts of exchanging the cash flow and are tailored to the needs of
counter parties. Swaps can meet the specific needs of customers.
Counter parties can select amount, currencies, maturity dates etc.
Exchange trading involves loss of some privacy but in the swap market privacy
exists and only the counter parties know the transactions.
There is no regulation in swap market.
There are some limitations like
a) Each party must find a counter party which wishes to take opposite
position.
b) Determination requires to be accepted by both parties.
c) Since swaps are bilateral agreements the problem of potential default
exists.
Various types of interest rate swap
Following are the most important types of interest rate swap:
Plain vanilla swap: this swap involves the periodic exchange of fixed arte payment
for floating rate payments. It is sometimes referred as fixed for floating interest
rates.
 Forward swap: This involves an exchange of interest rate payment that does not
begin until a specified future point in time. It is a swap involving fixed for floating
interest rates.
Callable swap: Another use of swap is through swap option (swaptions). A callable
swap provide a party making the fixed payment it the right to terminate the swap
prior to its maturity. It allows a fixed rate payer to avoid exchanging future interest
rate payments it its so desired.
Putable swap: it provides the party making the floating rate payments with a right
to terminate swap.
Extendable swap: it contains extendable feature that allows fixed for floating party
to extend the swap period.
Zero coupon for floating swap: in this swap, the fixed rate pair makes a bullet
payment at the end and floating rate pair makes the periodic payment throughout
the swap period.
Rate capped swaps: this involves the change of fixed rate payments for floating rate
payments whereby the floating rate payments are capped. An upfront fee is paid by
the floating rate party to fixed rate party fro the cap.
Equity swaps: an equity swap is a financial derivative contract where a set of future
cash flows are agreed to be exchanged between two counterparties at set dates in
the future.

Q.4) Elaborate on measuring exchanges rate movements. Explain the factors that influence
exchange rates.
Ans: - Exchange rates respond quickly to all sorts of events both economic and non-economic.
The movement of exchange rates is the result of the combined effect of a number of factors
that are constantly at play. Economic factors, also called fundamentals, are better guides as
to how a currency moves in the long run. Short-term changes are affected by a multitude of
factors which may also have to be examined carefully.
In recent years, global interdependence has increased to an unprecedented degree. Changes
in one nations economy are rapidly transmitted to that nations trading partners. These
fluctuations in economic activity are reflected almost immediately in fluctuations of currency
values. These changes in exchange rates expose all those firm having export import
operation as also multinational with integrated cross border production and marketing
operations.
Interest rate differentials
Foreign exchange markets and exchange rates are quite sensitive to movements in interest
rates. This is because financial markets were becoming more closely linked due to
(i) Growing interest in international investment;
(ii) Elimination or constraints on mobility of capital to large extent;
(iii) More rapid means of communications.
Most investors would like to move their funds a country having lower interest rates to a
country having higher interest rates. Such funds are usually termed as hot money. If the
interest rate in the UK is higher than the interest rate in the USA, investors would find it
profitable to invest funds in the UK and would purchase pounds and sell dollars in the spot
market, leading to an upward movement in pound sterling. In fact, the UK very often uses
interest rate as a weapon to push the pound.

Focus on the Demand-Supply Model

The demand factor
At the most primary level, a change in the price of a currency will occur because of more or
less demand for it. High demand signifies higher price experience of the currency pair. Less
demand signifies fall in the price of the currency pair.
The supply side factor
A basic economic principle of supply says that a currencys value will change with the rise
and fall of the levels of supply. The value and price of currency will diminish if there is a
higher supply of a currency. Similarly, the value and price of a currency will increase when
there is a lower supply of a currency.
Long term vs. short term
A time period of a year or more signifies a long-term supply and demand. Short-term is
generally thirty days or less than that. The currency prices in both the time periods can be
affected by the same factors. A trader should be conscious of the time factor in which a
trades is placed. Long and short-term price movements can happen in parallel.
Factors affecting currency trading
A number of factors affect the rates of exchange. At the end, costs of currency result from
the supply of currency. The currency markets all over the world can be considered a huge
melting pot. The supply and demand ingredients constantly change in relation to the
changing mix of current event and the cost of one currency in relation to another change
accordingly.
Economic factors
These include the economic policy of the government which is made known through various
government agencies and the central bank of the country, and economic condition,
generally revealed through economic reports. Economic conditions include:
Inflation levels and trends: if there is a high level of inflation in the country, or if the
inflation level seems to be rising, typically a currency will lose value because
inflation brings down the purchasing power and thus the demand for that particular
currency.
Economic growth and health: the economic growth and health of a country can be
known through a countrys gross domestic product level of employment, capacity
utilization, retail sales and other indicators. Generally, a currency will perform
better and there will be more demand for it if the economy of the country is healthy
and robust.
Government budget deficits or surpluses: widening government budget deficits
lead to a negative reaction in the market, whereas the market reacts positively in
case of narrowing budget deficits. The impact of budget deficit or budget surplus is
reflected in the value of the currency of a country.
Balance of trade levels and trends: the flow of trade a country to other parts of the
world shows the demand for goods and services of the country, which in turns
indicates the demand for a countrys currency for conducting trade. The
 competitiveness of a countrys economy is reflected by the surpluses and deficits in
trade of goods and services.
Political conditions
Internal, regional and international political conditions and issues can profoundly affect
currency markets; for instance, political upheaval and instability can negatively impact
the economy of a nation. Similarly, the growth of a political faction that is considered to
be fiscally responsible can have a positive opposite effect on the economy.

Q.5) Write short notes on: -

International Credit Market
International Bond Market
Ans: - International credit markets are the forum where companies and governments can obtain
credit (loans in various forms) from the creditors/investors. These markets are an important
part of international capital markets. Two very important aspects of international credit
market are the syndicated loans and impact of credit crisis on the credit market, which are
explained below.
Syndicated Loans
Syndicated loans are credits granted by group of banks, called a syndicate to a borrower who
may be a company or the government. Interest rates can be fixed for the term of the loan or
floating based on benchmark rate such as the London Interbank Offered Rate (LIBOR). These
are hybrid instruments combining features of relationship lending and publicly trade debt.
These allow sharing of credit risk between various financial institutions without the
disclosure and marketing burden that bond issuers face.
External Commercial Borrowing (ECB)
ECBs refer to loans from commercial banks, suppliers credit, buyers credit, fixed rate
bonds, floating rate notes, credit from authorized export credit agencies, and loans from
institutions such as IFC (International Finance Corporation), ABD (Asian Development Bank)
and CDC (Commonwealth Development Corporation). Guidelines for ECBs were first
liberalized in India in 1997. Ever since then, corporation firms have been allowed to raise
capital for expanding existing capacity, making new investments and finance working capital.
All infrastructure and Greenfield projects are allowed to make use of ECB up to 35 per cent
of total project expenses. The average maturity time of ECBs ranges from three to five to
seven years. ECBs are mostly used for:
(a) Project related cost of infrastructure projects
(b) License fee payments in the telecom sector
(c) Foreign exchange cost of capital goods and services

International Bond Markets

Although debt financing has always been international in nature, there is still no unified
international bond market the international bond market is divided into three bond market
groups:
1. Domestic bond: they are issued locally by a domestic borrower and are usually
denominated in the local currency.
 2. Foreign bonds: They are issued on a local market by a foreign borrower and are usually
denominated in the local currency. Foreign bond issues and trading are under the
supervision of local market authorities.
3. Eurobonds: they are underwriting by a multinational syndicate of banks and placed
mainly in countries other than the one in whose currency the bond is denominated.
These bonds are not traded on a specific national bond market.

Q.6) Country risk is the risk of investing in a country, where a change in the business
environment adversely affects the profit or the value of the assets in a specific country.
Explain the country risk factors and assessment of risk factors.
Ans: - We can define country risk as the risk of losing money due to changes that can occur in a
countrys government or regulatory environment. The most common examples are acts war,
civil wars, terrorism and military coups, etc. It comes in various forms: for example, change
in the government of a country, a new president or prime minister, some new laws, a ruling
party becoming minority, and so on. Such changes do impact a countrys economic
environment. They have a great impact on the investors perception about a countrys
prospects.
Political stability means the frequency of changes in the government of a country, the level
of violence in the country, etc. A country is called politically stable if there are no frequent
changes in the government and the level of violence is low or nil. For example, Australia was
considered a dream destination by Indian earlier. Now the country is being avoided due to
the instances of violence against Indians. In some countries, government can expropriate
either a legal title to property or the stream of income it generates. Such countries are said
to be high political risk countries. Political risk is also said to exist if property owners may be
constrained in the way they use their property.
Country-related factors: These have three broad categories that have been discussed in
detail.
(a) Economic factors
Fiscal discipline: This is indicated by the ratio of the fiscal deficit of a country to
its GNP. Higher the ratio, the more government is promising to its population
relative to resources it is obtaining from them.
Controlled exchanges rate system: This system increase the problem of BOP
and makes fiscal discipline difficult. Government uses currency controls to fix
exchanges rates. This provides little flexibility to respond to changing prices.
Wasteful government expenditure: This is an indicators of financial problems.
Resource base: if a country has natural resources, it is considered economically
stable.
Countrys capacity to adjust to external shocks: if a country has a vast
resources base, it possesses greater capacity to respond to external shocks.
(b) Geographical factors: the best example in this case would be Sri Lanka, Where due to
the presence of the LTTE, there was a border issue.
(c) Sociological factors: These include religious diversity, language diversity, ethnic
diversity, etc.
Assessment of Risk Factors
These are risk assessment agencies that provide country risk indices which try to assess the
political stability of a country. The factors from which the political instability occurs can be
classified into three categories:
(a) Economic factors: these factors include inflation, unemployment, fiscal deficit, trade
policies, large external debt, etc.
(b) Geographic factors: These include border disputes, natural calamities, etc.
(c) Sociological factors: these include religious diversity, diversity in language, etc.