International Financial Management M.B.S Final Chapter -1 1) What is International Finance?

ce? Ans: The term International Finance is defined as the economic interaction among different nations involving the monetary payments and the exchange of currency. The basis of international finance is foreign exchange, including foreign exchange markets and exchange rates. 2) Discuss the importance of International Finance / International Financial Management. Ans: International financial management deals with the financial decision taken in the area of International business. Todays world axed the trade barriers significantly over the years, as a result of which International trade grew multiple. Naturally the financial involvement of traders, exporters, importers, and the quantum of the cross country transactions surged significantly. All these require proper management of international flow of fund. For this, International financial management has become important. The second reason is fast expansion of multinational companies. And by their operation, the cross country flow of fund increased substantially. The two way flow of funds, outward in the form of investment and inward in the form of repatriation divided, royalty, and technical service fees require proper management. And for doing it, efficient international financial management is must. The third reason is that the complexity of financial decision of MNC. Todays MNC are more interested in maximizing the value of global wealth. And to mange it quite well, International financial management helps a lot. The fourth reason is, a vast magnitude of lending international and regional development asks. The movement of fund from developed countries and the reverse movement of funds in form of interest and amortization payments need proper management. The final reason is, we are growing international and form of financial instruments and markets became international. The need of citizen currently has no political border. So to fulfill their wants, the risks over Accumulated by: Subrata Kumar Shil Cell: 01811 483356 and 01919 037036 E-mail: subratashil@gmail.com 1

foreign currencies become huge. With the efficient international financial management, we can find the most suitable technique to be applied at a particular moment and in a particular case in order to hedge risk. 3) What is Multinational Company? What economic roles do they play? Ans: Multinational Company or transnational company is defined as a company which maintains its assets and operations in more than country. A multinational corporation often has a long supply chain that may, for example require the acquisition of raw materials in one country, a products manufacture in another country, and its retail sale in a third country. A multinational often globally manages its operations from a main office in its home country. They recruit human resources from their operational countries or may from any part of the world. Multinationals create wealth in every country where they operate, which ultimately benefits workers as well as shareholders. For example Toyota, Nokia, Honda, Volkswagen etc. Economic roles played by Multinationals: 1) Economic growth and employment: MNC bring inward investment in such country which is not their home base. This huge investment is likely to provide a boost, not only to the local economy but also to the national economy. 2) Skills, production techniques and improvements in the human capital: MNCS new ideas and new techniques can help to improve the quality of production and help boost the quality of human capital in the host country. Many will not only look to local labor but also provide them with training and new skills to help them improve productivity and efficiency. 3) Availability of quality goods and services in the host country: Production in a host country may be primarily aimed as to export. However the inward investment might have been made to gain access to the host country to circumvent trade barriers. In the case of many Japanese car manufacturers the investment made into UK production has enabled them to get a foothold in the EU and to avoid tariff barriers. 4) Tax Revenue: For operating in host country, MNC has become a tax regime of the country. 5) Improvement of infrastructure: In addition to the investment in a country in production or distribution facilities, a company might also invest in additional infrastructure facilities like road, port etc. That can provide benefits for the whole country.

Accumulated by: Subrata Kumar Shil Cell: 01811 483356 and 01919 037036 E-mail: subratashil@gmail.com

MNC plays a vital role for the economy. It not only provides us employment, revenues, good products but also provide positive images for the country. That is really very important for showing stability to gain foreign investment more. But it is to be needed to check that MNC is not supposed to take the whole profit they made by using the host country. 3) Identify the main goal of Multinational Company and the potential conflicts with that goal. Ans. The main goal of multinational company is to maximize shareholders wealth. But if the company wants to maximize their earnings in the near future, rather than to maximize shareholders wealth, the firms policies would be different. Potential conflicts: Conflicts encountered in meeting goals 1) Agency problems larger for MNC ARE than purely domestic firms because: a) monitoring more difficult because of geographic distance b) Different cultures c) MNC size d) Subsidiary managers may maximize the value of their subsidiary but not of the MNC as a whole 2) Centralized vs. decentralized management a) centralized reduces agency costs because it gives parent more control; downside is that local managers may be better informed b) Decentralized management increases agency costs but may result in better decisions c) Internet may facilitate monitoring of foreign subsidiaries 3) Corporate control used to reduce agency problems a) executive compensation with stock b) threat of hostile takeover c) monitoring by large shareholders 4) Describe the key theories which justify international business. Accumulated by: Subrata Kumar Shil Cell: 01811 483356 and 01919 037036 E-mail: subratashil@gmail.com 3

Ans: Theories which justify the international business are provided below Theory of comparative advantages: - Countries specialize in the production of goods; they can produce with relative efficiency and trade for other products. Theory of imperfect markets: - Factors of production (labor and other resources) are immobile. Theory of product cycle: - Firm introduces product in home market, then exports it, then establish a subsidiary, and then differentiate the product. 5) Explain the common methods used to conduct international business. Ans: International Trade: - Export and Import - Low risk - Internet facilities advertising and sales Licensing: - Obligate firm to provide its technology in exchange for fees or other benefits. E.g. - ATT&T and Nynex Corporation had licensing to build Indias telephone system. Franchising: Obligates firm to provide a specialized sales or service strategy, support assistance and possibly an initial investment in exchange for periodic fees Joint Ventures: A venture that is jointly owned and operated by two or more firms Allow firms to apply comparative advantage (e.g., General Mills and Nestle) Acquisitions of Existing Operations: Acquire a firm in a foreign country to penetrate foreign markets Advantage: full control over foreign business Disadvantage: risky because of large investment and uncertainty Some firms make partial acquisitions, but these do not allow full control even though they are less risky Establishing New Foreign Subsidiaries: Establish new operations in foreign country to penetrate market Advantage: can tailor exactly to firms needs Accumulated by: Subrata Kumar Shil Cell: 01811 483356 and 01919 037036 E-mail: subratashil@gmail.com 4

Disadvantage: must establish customer base, unfamiliarity with local customs Methods requiring a direct investment are referred to as direct foreign investment (DFI): Includes franchising, joint ventures, acquisitions, and foreign subsidiaries 6) What are the typical reasons why MNCS expand internationally? Ans: The reasons are provided below Opportunities of 1) Higher growth potential 2) Larger investment opportunity set 3) Lower borrowing costs due to more funding source 4) Result in lower cost of capital and higher returns for projects. Exposure to international risk 1) Less exposure to domestic economy 2) Can avoid political risk if any. Opportunities in various regions 1) Europe: a) Single European Act 1987, b) inception of the euro. 2) Latin America: a) NAFTA, b) GATT 3) Asia: Large population base. 6) Identify the risk faced by multinational companies which expand internationally? Ans: Risks faced by multinational company is provided below 1) Exposure to exchange rate movements 2) Exposure to foreign economics 3) Exposure to political risk Synopsis: 1) Exposure to exchange rate movements: Exchange rates are the amount of one countrys currency needed to purchase one unit of another currency. Dealing with very large amount of money by multinational companies in their transactions, the rise or fall of a currency can mean getting a surplus or deficit in their balance sheet. One type exchange risk is Transaction Risk. If a company sells products to an overseas customer it might be subject to transaction risk. Other type of exchange rate risk is Accumulated by: Subrata Kumar Shil Cell: 01811 483356 and 01919 037036 E-mail: subratashil@gmail.com 5

called translation risk. This risk relates to cases where large manufacturing companies have subsidiaries in other countries. 2) Exposure to Political Risk: For MNC, political risk refers to the risk that a host country will make political decisions that will prove to have an adverse effect on MNCS profit and goals. Two types of political risk a) Macro risk (Refers to an adverse action that will affect all foreign firms) and - b) Micro Risk (Refers to an adverse action which will affect particular industrial sector or business). Terrorism is a major political risk recently facing by the MNC so much. 3) Exposure to Foreign Economics: When MNCS enter foreign markets to sell products; the demand for these products is dependent on the economic conditions in those markets. Thus the cash flows of the MNC are subject to foreign economic conditions. 7) Explain the agency problem by Multinational Companies. Why might the agency cost be larger for a MNCs than for a domestic firm? Ans: The agency problem reflects a conflict between decision making managers and the owners of the MNC. Agency cost occurs in an effort to assure that managers act in the best interest of the owners. Again if the subsidiaries made their own decisions, the agency cost would be higher since the parent needs to monitor the subsidiaries to assure that their decisions were intended to maximize shareholders wealth. The agency costs are normally larger for MNCS than purely domestic firms for the following reasons. First MNC incur large agency costs in monitoring of distant foreign subsidiaries. Second Foreign subsidiary managers raised in different cultures may not follow uniform goals. Third The sheer size of the larger MNCs would also create large agency problems. 8) Describe the constraints which interfering the MNCs goal. Ans: When financial manager of MNC attempt to maximize their firms value, they are confronted with various constrains that can be classified as environmental, regulatory or ethical in nature. 1) Environmental Constrains: Each country enforces its own environmental constrains. Some countries may enforce more of these restrictions on a subsidiary whose parent is based in a different country. Building codes, disposal of production waste materials, and pollution controls are examples of restrictions that force subsidiaries to incur additional costs. Many European Accumulated by: Subrata Kumar Shil Cell: 01811 483356 and 01919 037036 E-mail: subratashil@gmail.com 6

countries have recently imposed tougher antipollution laws as a result of severe pollution problems. 2) Regulatory Constrains: Each country also enforces its own regulatory constrains pertaining to taxes. Currency convertibility rules, earnings remittance restrictions, and other regulations that can affect cash flows of a subsidiary established there. 3) Ethical Constrains: There is no census standard of business conduct that applies to all countries. A business practice that is perceived to be unethical in one country may be totally ethical in another. For example Bribes, Sexual product in Arab countries. 9) Explain why political risk may discourage international business? Ans: Political risk refers to the risk that a host country will make political decisions that will prove to have an adverse effect on multinationals profit and goals. Basically political risk increases the rate of return required to invest in foreign projects. Some foreign projects would have been feasible if there was no political risk, but will not be feasible because of political risk. There are various types of political risk which discourage international business. We can make a matrix form about this Firm Specific risk Government Risk Instability Risk - Discriminatory Regulations - Sabotage - Breach of contract - kidnappings - Terrorism - Firm-specific boycotts - Mass Nationalizations - Mass labor strikes - Regulatory changes - Urban rioting - Currency Inconvertibility - Civil wars.

Country level risk

With effective political risk management by CFOs can make significant impact to the removal process of such discouragements.

Accumulated by: Subrata Kumar Shil Cell: 01811 483356 and 01919 037036 E-mail: subratashil@gmail.com