International

financial
management
INTRODUCTION
Introduction
International financial management, also known as international finance, is the management of

finance in an international business environment;

that is, trading and making money through the exchange of foreign currency. The international

financial activities help the organizations to connect with international dealings with overseas

business partners- customers, suppliers, lenders etc.

It is also used by government organization and non-profit institutions

 Part I
The International Financial Environment
Multinational Corporation (MNC)

Foreign Exchange Markets

Dividend
Remittance
Exporting Investing
& Financing
& Importing & Financing

Product Markets Subsidiaries International

Financial
Markets
Historical perspective of
Internationalization
1. World War 1 (Economies were disintegrated)

2. The great depression of 1930 (followed by war , had vastly diminished commercial trade, international

exchange of currencies and cross boarder lending and borrowing).

3. World War II (1939) whole the economic systems were changed and remains were memories.

4. Revival period. (Nations were agreed to entail new institutions and political agreements)

5. End of the World War II (1945 Sep) can be taken as year zero for the current system of international

finance.

6. In 1944 (Restructuring of postwar financial system began with the bretton wood agreement)
Historical perspective of
Internationalization (Vision of post war monetary arrangement)
The Bretton Woods Agreement was negotiated in July 1944 by delegates from 44 countries at the United
Nations Monetary and Financial Conference held in Bretton Woods, New Hampshire. Thus, the name
“Bretton Woods Agreement.

Under the Bretton Woods System, gold was the basis for the U.S. dollar and other

currencies were pegged to the U.S. dollar’s value. The Bretton Woods System

effectively came to an end in the early 1970s when President Richard M. Nixon

announced that the U.S. would no longer exchange gold for U.S. currency
 LIBERLIZATION

International Financial Management came into being

when the countries of the world started opening their

doors for each other. This phenomenon is well known by

the name of “liberalization”. Due to the open

environment and freedom to conduct business in any

corner of the world, Businesses started looking for

opportunities even outside their country boundaries .

Historical perspective of
Internationalization (International financial Institutions)
World Bank
The World Bank was created at the 1944 Bretton Woods Conference, along with the 
International Monetary Fund (IMF). 

It provides loans and grants to the governments of low- and middle-income countries for the
purpose of pursuing capital projects
Historical perspective of
Internationalization (International financial Institutions)
International Monitory Fund (IMF)
Created in 1945, Its purpose would be to lend foreign exchange to any member whose supply of foreign
exchange had become scarce. The IMF's primary purpose is to ensure the stability of the international
monetary system—the system of exchange rates and international payments that enables countries (and
their citizens) to transact with each other. 
the IMF is governed by and accountable to the 190 countries that make up its near-global membership.
Trade expansion goal
The General Agreement on Tariffs and Trade (GATT) is a multi-national trade treaty. It has
been updated in a series of global trade negotiations consisting of nine rounds between 1947
and 1995. Its role in international trade was largely succeeded in 1995 by the 
World Trade Organization.

The World Trade Organization (WTO) is an 

intergovernmental organization that is concerned with the
regulation of international trade between nations.
 The Multinational Corporation
Multinational Corporation (MNC) and its goal:

We can define an MNC simply as a corporation operating in more than one

country.

The goal or objective of the MNC should be the maximization of

stockholders' wealth or the stock price.

This objective is the same for purely domestic corporations as well.

Stockholder Wealth equals Stock Price * # of Shares Outstanding.

Goal of the MNC
The commonly accepted goal of an MNC is to maximize shareholder wealth.
 Conflicts Against the MNC Goal
For corporations with shareholders who differ from their managers, a conflict of goals can exist - the
agency problem.

Agency costs are normally larger for MNCs than for purely domestic firms.
◦ The sheer size of the MNC.
◦ The scattering of distant subsidiaries.
◦ The culture of foreign managers.
◦ Subsidiary value versus overall MNC value.
Impact of Management Control
The magnitude of agency costs can vary with the management style of the MNC.

A centralized management style reduces agency costs. However, a decentralized style gives more
control to those managers who are closer to the subsidiary’s operations and environment.
Impact of Management Control
Some MNCs attempt to strike a balance - they allow subsidiary managers to make the key
decisions for their respective operations, but the decisions are monitored by the parent’s
management.
Impact of Management Control
Electronic networks make it easier for the parent to monitor the actions and performance of
foreign subsidiaries.

For example, corporate intranet or internet email facilitates communication. Financial reports and
other documents can be sent electronically too.
Impact of Corporate Control
Various forms of corporate control can reduce agency costs.
◦ Stock compensation for board members and executives.
◦ The threat of a hostile takeover.
◦ Monitoring and intervention by large shareholders.
Constraints
Interfering with the MNC’s Goal
As MNC managers attempt to maximize their firm’s value, they may be confronted with various
constraints.
◦ Environmental constraints.
◦ Regulatory constraints.
◦ Ethical constraints.
 Theories of International Business
Why are firms motivated to expand their business
internationally?
Theory of Comparative Advantage
◦ Specialization by countries can increase production efficiency.

Imperfect Markets Theory

◦ The markets for the various resources used in production are “imperfect.”
 Theories of International Business
Why are firms motivated to expand their business
internationally?
Product Cycle Theory
◦ As a firm matures, it may recognize additional opportunities outside its home country.
International
Business Methods
There are several methods by which firms can conduct international
business.
International trade is a relatively conservative approach involving exporting and/or importing.
◦ The internet facilitates international trade by enabling firms to advertise and manage orders through their
websites.
International
Business Methods
Licensing allows a firm to provide its technology in exchange for fees or some other benefits.

Franchising obligates a firm to provide a specialized sales or service strategy, support assistance,
and possibly an initial investment in the franchise in exchange for periodic fees.
International
Business Methods
Firms may also penetrate foreign markets by engaging in a joint venture (joint ownership and
operation) with firms that reside in those markets.

Acquisitions of existing operations in foreign countries allow firms to quickly gain control over
foreign operations as well as a share of the foreign market.
International
Business Methods
Firms can also penetrate foreign markets by establishing new foreign subsidiaries.

In general, any method of conducting business that requires a direct investment in foreign
operations is referred to as a direct foreign investment (DFI).

The optimal international business method may depend on the characteristics of the MNC.
International Opportunities
Investment opportunities - The marginal return on projects for an MNC is above that of a purely
domestic firm because of the expanded opportunity set of possible projects from which to select.

Financing opportunities - An MNC is also able to obtain capital funding at a lower cost due to its
larger opportunity set of funding sources around the world.
International Opportunities
Investment opportunities - The marginal return on projects for an MNC is above that of a purely
domestic firm because of the expanded opportunity set of possible projects from which to select.

Financing opportunities - An MNC is also able to obtain capital funding at a lower cost due to its
larger opportunity set of funding sources around the world.
International Opportunities
Opportunities in Asia
◦ The reduction of investment restrictions by many Asian countries during the 1990s.
◦ China’s potential for growth.
◦ The Asian economic crisis in 1997-1998.
 Exposure to International Risk
International business usually increases an MNC’s exposure to:

exchange rate movements

◦ Exchange rate fluctuations affect cash flows and foreign demand.

foreign economies
◦ Economic conditions affect demand.

political risk
◦ Political actions affect cash flows.
Managing for Value
Like domestic projects, foreign projects involve an investment decision and a financing decision.

When managers make multinational finance decisions that maximize the overall present value of
future cash flows, they maximize the firm’s value, and hence shareholder wealth.
 Valuation Model for an MNC
Domestic Model

E CF t
n


Value
=
t
= 11 
k
$,

 t

E (CF$,t ) = expected cash flows to be received at the end of period t

n = the number of periods into the future in which cash flows are received
k = the required rate of return by investors
Valuation Model for an MNC
Valuing International Cash Flows

 
 CF
j,t  ER
j,t   
m

n

 E E


Value
= 
j
1

1 k t 
t=
1 

 

E (CFj,t ) = expected cash flows denominated in currency j to be received by the
U.S. parent at the end of period t
E (ERj,t ) = expected exchange rate at which currency j can be converted to
dollars at the end of period t
k = the weighted average cost of capital of the U.S. parent company
Valuation Model for an MNC
An MNC’s financial decisions include how much business to conduct in each country and how
much financing to obtain in each currency.

Its financial decisions determine its exposure to the international environment.

 Valuation Model for an MNC
Impact of New International Opportunities
on an MNC’s Value

Exposure to
Foreign Economies Exchange Rate Risk

 
 CF
j,t  ER
j,t  
m

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
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
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Value
= 
j
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1 k t 
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Political Risk