Q1 Discuss international finance and its management in present business

environment. How it is different from financial management?

 Introduction:-

One of the most dramatic and significant world trends in the past two
decades has been the rapid, sustained growth of international business. Markets have become
truly global for most goods, many services, and especially for financial instruments of all types.
World product trade has expanded by more than 6 percent a year since 1950, which is more than
50 percent faster than growth of output the most dramatic increase in globalization, has occurred
in financial markets. In the global forex markets, billions of dollars are transacted each day, of
which more than 90 percent represent financial transactions unrelated to trade or investment.
Much of this activity takes place in the so-called Euromarkets, markets outside the country
whose currency is used. This pervasive growth in market interpenetration makes it increasingly
difficult for any country to avoid substantial external impacts on its economy. In particular
massive capital flows can push exchange rates away from levels that accurately reflect
competitive relationships among nations if national economic policies or performances diverse in
short run. The rapid dissemination rate of new technologies speeds the pace at which countries
must adjust to external events. Smaller, more open countries, long ago gave up illusion of
domestic policy autonomy. But even the largest and most apparently self-contained economies,
including the US, are now significantly affected by the global economy. Global integration in
trade, investment, and factor flows, technology, and communication has been tying economies
together. Why then are these changes coming about, and what exactly are they? It is in practice,
easier to identify the former than interpret the latter. The reason is that during the past few
decades, the emergence of corporate empires in the world economy, based on the contemporary
scientific and technological developments, has led to globalization of production. As a result of
international production, co-operation among global productive units, the large-scale capital
exports, the export of production‖ or production abroad‖ has come into prominence as against
commodity export in world economy in recent years. Global corporations consider the whole of
the world their production place, as well as their market and move factors of production to
wherever they can optimally be combined. They avail fully of the revolution that has brought
about instant worldwide communication, and near instant-transformation. Their ownership is
transnational; their management is transnational. Their freely mobile management, technology
and capital, the modern agent for stepped-up economic growth, transcend individual national
boundaries. They are domestic in every place, foreign in none-a true corporate citizen of the
world. The greater interdependence among nations has already reduced economic insularity of
the peoples of the world, as well as their social and political insularity.
  Definition:-
 International business includes any type of business activity that crosses national borders.
Though a number of definitions in the business literature can be found but no simple or
universally accepted definition exists for the term international business.
 At one end of the definitional spectrum, international business is defined as organization
that buys and/or sells goods and services across two or more national boundaries, even if
management is located in a single country.
 At the other end of the spectrum, international business is equated only with those big
enterprises, which have operating units outside their own country.
 n the middle are institutional arrangements that provide for some managerial direction of
economic activity taking place abroad but stop short of controlling ownership of the
business carrying on the activity, for example joint ventures with locally owned business
or with foreign governments.
 In its traditional form of international trade and finance as well as its newest form of
multinational business operations, international business has become massive in scale and
has come to exercise a major influence over political, economic and social from many
types of comparative business studies and from knowledge of many aspects of foreign
business operations.

NATURE AND SCOPE OF INTERNATIONAL FINANCIAL MANAGEMENT:-

Like any finance function, international finance, the finance function of a

multinational firm has two functions namely, treasury and control. The treasurer is responsible
for financial planning analysis, fund acquisition, investment financing, cash management,
investment decision and risk management. On the other hand, controller deals with the functions
related to external reporting, tax planning and management, management information system,
financial and management accounting, budget planning and control, and accounts receivables
etc. For maximising the returns from investment and to minimize the cost of finance, the firms
has to take portfolio decision based on analytical skills required for this purpose. Since the firm
has to raise funds from different financial markets of the world, which needs to actively exploit
market imperfections and the firm’s superior forecasting ability to generate purely financial
gains. The complex nature of managing international finance is due to the fact that a wide variety
of financial instruments, products, funding options and investment vehicles are available for both
reactive and proactive management of corporate finance. Multinational finance is
multidisciplinary in nature, while an understanding of economic theories and principles is
necessary to estimate and model financial decisions, financial accounting and management
accounting help in decision making in financial management at multinational level. 5 Because of
changing nature of environment at international level, the knowledge of latest changes in forex
rates, volatility in capital market, interest rate fluctuations, macro level charges, micro level
economic indicators, savings, consumption pattern, interest preference, investment behaviour of
investors, export and import trends, competition, banking sector performance, inflationary
trends, demand and supply conditions etc. is required by the practitioners of international
financial management.

 Distinguishing features of international finance:-

International Finance is a distinct field of study and certain features set it apart from other fields.
The important distinguishing features of international finance from domestic financial
management are discussed below:

1. Foreign exchange risk:-

An understanding of foreign exchange risk is essential for managers and investors in the
modern day environment of unforeseen changes in foreign exchange rates. In 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 characterized 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. At present,
the exchange rates among some major currencies such as the US dollar, British pound,
Japanese yen and the euro fluctuate in a totally 6 unpredictable manner. Exchange rates
have fluctuated since the 1970s after the fixed exchange rates were abandoned. Exchange
rate variation affect the profitability of firms and all firms must understand foreign
exchange risks in order to anticipate increased competition from imports or to value
increased opportunities for exports.

2. Political risk:-

Another risk that firms may encounter in international finance is political risk. Political 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.
MNCs must assess the political risk not only in countries where it is currently doing business but
also where it expects to establish subsidiaries. The extreme form of political risk is when the
sovereign country changes the ‘rules of the game’ and the affected parties have no alternatives
open to them. For example, in 1992, Enron Development Corporation, a subsidiary of a Houston
based energy company, signed a contract to build India’s 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. The Enron
episode highlights the problems involved in enforcing contracts in foreign countries. Thus,
episode highlights the problems involved in enforcing contracts in foreign countries. Thus,
political risk associated with international operations is generally greater than that associated
with domestic operations and is generally more complicated.

3. Expanded opportunity sets:-

When firms go global, they also tend to benefit from expanded opportunities which are available
now. They can raise funds in capital 7 markets where cost of capital is the lowest. In addition,
firms can also gain from greater economies of scale when they operate on a global basis.

4. Market imperfections:-

The final feature of international finance that distinguishes it from domestic finance is that
world markets today are highly imperfect. There are profound differences among nations’ laws,
tax systems, business practices and general cultural environments. Imperfections in the world
financial markets tend to restrict the extent to which investors can diversify their portfolio.
Though there are risks and costs in coping with these market imperfections, they also offer
managers of international firm’s abundant opportunities.

 SPECIAL DIFFICULTIES IN INTERNATIONAL BUSINESS:-

What make international business strategy different from the domestic is the differences in the
marketing environment. The important special problems in international marketing are given
below:

1. POLITICAL AND LEGAL DIFFERENCES:-

The political and legal environment of foreign markets is different from that of the
domestic. The complexity generally increases as the number of countries in which a
company does business increases. It should also be noted that the political and legal
environment is not the same in all provinces of many home markets. For example, the
political and legal environment is not exactly the same in all the states of India.

2. CULTURAL DIFFERENCES:-

The cultural differences, is one of the most difficult problems in international marketing.
Many domestic markets, however, are also not free from cultural diversity.

3. ECONOMIC DIFFERENCES:-

The economic environment may vary from country to country.

4. DIFFERENCES IN THE CURRENCY UNIT:-

The currency unit varies from nation to nation. This may sometimes cause problems of
currency convertibility, besides the problems of exchange rate fluctuations. The monetary
system and regulations may also vary.

5. DIFFERENCES IN THE LANGUAGE:-

An international marketer often encounters problems arising out of the differences in the
language. Even when the same language is used in different countries, the same words of
terms may have different meanings. The language problem, however, is not something
peculiar to the international marketing. For example: the multiplicity of languages in
India.

6. DIFFERENCES IN THE MARKETING INFRASTRUCTURE:-

The availability and nature of the marketing facilities available in different countries may
vary widely. For example, an advertising medium very effective in one market may not
be available or may be underdeveloped in another market.

7. TRADE RESTRICTIONS:-

A trade restriction, particularly import controls, is a very important problem, which an

international marketer faces.

8. HIGH COSTS OF DISTANCE:-

When the markets are far removed by distance, the transport cost becomes high and the
time required for affecting the delivery tends to become longer. Distance tends to
increase certain other costs also.

9. DIFFERENCES IN TRADE PRACTICES:-

Trade practices and customs may differ between two countries.

Q2). What are spot and forward markets? Discuss the factors which influence the
forward agreement in currency exchange?
 Introduction:-
 Spot market:-

The spot market is where financial instruments, such as commodities, currencies and

securities, are traded for immediate delivery. Delivery is the exchange of cash for the financial
instrument. A futures contract, on the other hand, is based on the delivery of the underlying asset
at a future date. Exchanges and over-the-counter (OTC) markets may provide spot trading and/or
futures trading. 

Spot markets are also referred to as “physical markets” or “cash markets” because trades
are swapped for the asset effectively immediately. While the official transfer of funds between
the buyer and seller may take time, such as T+2 in the stock market and in most currency
transactions, both parties agree to the trade “right now.” A non-spot, or futures transaction, are
agreeing to a price now, but delivery and transfer of funds will take place at a later date. Futures
trades in contracts that are about to expire are also sometimes called spot trades since the
expiring contract means that the buyer and seller will be exchanging cash for the underlying
asset immediately.

 Forward market:-

A forward market is an over-the-counter marketplace that sets the price of

a financial instrument or asset for future delivery. Forward markets are used for trading a range
of instruments, but the term is primarily used with reference to the foreign exchange market. It
can also apply to markets for securities and interest rates as well as commodities.

Forward contracts differ from future contracts in that they are customizable in
terms of size and length, or maturity term.Forward contract pricing is based on interest rate
discrepancies. The most commonly traded currencies in the forward market are the same as on
the spot market: EUR/USD, USD/JPY and GBP/USD.

A forward market leads to the creation of forward contracts. While forward

contracts like futures contracts may be used for both hedging and speculation, there are some
notable differences between the two. Forward contracts can be customized to fit a customer's
requirements, while futures contracts have standardized features in terms of their contract
size and maturity. Forwards are executed between banks or between a bank and a customer;
futures are done on an exchange, which is a party to the transaction. The flexibility of forwards
contributes to their attractiveness in the foreign exchange market.

 Meaning:-

Spot Price:-
The current price of a financial instrument is called the spot price. It is the price at
which an instrument can be sold or bought at immediately. Buyers and sellers create the spot
price by posting their buy and sell orders. In liquid markets, the spot price may change by the
second, as orders get filled and new ones enter the marketplace.

Spot Market and Exchanges:-

Exchanges bring together  dealers and traders who buy and sell commodities,
securities, futures, options and other financial instruments. Based on all the orders provided by
participants, the exchange provides the current price and volume available to traders with access
to the exchange. The New York Stock Exchange (NYSE) is an example of an exchange where
traders buy and sell stocks. This is a spot market.

Forward Pricing:-
Prices in the forward market are interest-rate based. In the foreign exchange
market, the forward price is derived from the interest rate differential between the two
currencies, which is applied over the period from the transaction date to the settlement date of
the contract. In interest rate forwards, the price is based on the yield curve to maturity.

Foreign Exchange Forwards:-

Interbank forward foreign exchange markets are priced and executed as swaps.
This means that currency A is purchased vs. currency B for delivery on the spot date at the spot
rate in the market at the time the transaction is executed. At maturity, currency A is sold vs.
currency B at the original spot rate plus or minus the forward points; this price is set when the
swap is initiated.

The interbank market usually trades for straight dates, such as a week or a month
from the spot date. Three- and six-month maturities are among the most common, while the
market is less liquid beyond 12 months. Amounts are commonly $25 million or more and can
range into the billions.

Customers, both corporations and financial institutions such as hedge funds and
mutual funds, can execute forwards with bank counter-party either as a swap or an outright
transaction. In an outright forward, currency A is bought vs. currency B for delivery on the
maturity date, which can be any business day beyond the spot date. The price is again the spot
rate plus or minus the forward points, but no money changes hands until the maturity date.
Outright forwards are often for odd dates and amounts; they can be for any size.

 Definition:-

Spot market:-

 Financial instruments trade for immediate delivery in the spot market.

 Many assets quote a “spot price” and a “futures or forward price.”
 Most spot market transactions have a T+2 settlement date.
 Spot market transactions can take place on an exchange or over-the-counter.
Forward market:-

 Forward contracts differ from future contracts in that they are customizable in terms of
size and length, or maturity term.
 Forward contract pricing is based on interest rate discrepancies.
 The most commonly traded currencies in the forward market are the same as on the spot
market: EUR/USD, USD/JPY and GBP/USD.

 Factors:-

1. FCNR Deposits and the Forward Rate:

Under the Foreign Currency Non-residents (FCNR-B) deposit scheme, banks can swap foreign
currency deposits for rupees in the market. (Under an earlier FCNR-A scheme, now
discontinued, such swaps were done with RBI, at level rates). Swap is a kind of transaction
which banks enters, to hedge their position of foreign exchange.

They are always in a position in foreign exchange market viz. over-bought or over-sold. The
banker who is in over-bought position will need to provide home currency on the exchange date.

Thus, he will need to arrange for requisite home currency to get foreign currency. To hedge his
position to the variations in the foreign exchange market, he will also need to sell foreign
currencies; else he will have lots of foreign currency but no home currency to pay for it.

So when he sells foreign currency he hedges his position through availability of home currency
and can maintain his profits through the continuous changes happening in foreign exchange
market.

Bank also faces the same type of problems, with respect to interest amount receivables and
payables with respect to foreign currency. If the interest amount is not hedged in the forward
market, strictly speaking, it should be included in the “gap” limit referred to above.

A bank would swap FCNR deposits for rupees in the manner indicated, only if the overall cost of
generating the rupee resources is economic, i.e., when the forward margin is less than the interest
differentials between foreign currencies and rupees. Thus, the deposited banks are also a source
of demand in the forward market.

 2. Forward Margin:

The forward margin depends on the perceptions of the buyers and sellers of currencies in the
Indian market. The forward margin is called a premium on the currency whose forward rate is
costlier than the spot rate and a discount where the forward rate is cheaper. It is expressed in the
same currency as the spot rate and the general practice is to quote it as a discount or premium on
that i.e., reported currency.
 3. Delivery Options:
Delivery option refers to the option for choosing the value date within an agreed period. In the
interbank market, the option period may be limited to the extent of a calendar month, and can be
further broken down based on the need of the party, by considering the actual date of need.

One feature of the Indian market is that the delivery of a claim for foreign currency receivable is
considered as delivery of the foreign currency although the currency may be receivable after
some time.

For example, if a bank buys from an exporter a dollar bill of exchange drawn on the buyer
abroad, the exchange transaction, namely the purchase of dollars, is completed when the bill
itself is purchased. It will be readily seen that the bank would actually get the dollars only when
the buyer abroad will pay the bill in accordance with its tenor of maturity.

When the agreed value date for the transaction is in mid of the month, then the accepted standard
rule for rate quotations for option contracts is the worse rate among the beginning and end of the
option period, and is use by bank to quote to the customer.

It means that if a foreign currency is at a premium in the forward market, then the rate applicable
to the beginning of the option period will be quoted and used by bank for purchase of the foreign
currency from the trader or merchant. But, if the bank has to sell the foreign currency the rate
applicable at the end of the period will be applicable. This is done with a specific reason to gain
to be earned by banker.

If the foreign currency is at a discount the worse rate rule will be to load the highest discount in
the purchase rate, and the lowest in the sale rate.

In brief, for option forwards,

The basic principle for quoting a forward rate to the customer is the same as for spot rates, to
ascertain the wholesale market rate and add a load of margin. If the interbank spot rate is
Rs.42.53/56 and the one month discount on the rupee (i.e. premium on the dollar) is 5/6 ps, the
wholesale market rates for one month forward dollars are Rs.42.58/62.

The one month option forward customer rates, assuming a margin of 10 p, will be selling, or
offering, dollars (to importers, etc.) at Rs.42.72, and buying, or bidding for dollars (from
exporters, etc.) at Rs.42.48. The one month fixed date delivery rates will be Rs.42.48/42.72.

4. Card Rates for Customer Transactions:

Banks in India have either a central interbank trading office for foreign exchange operations (the
FX Treasury), or at best can have offices in two or three major centers. The customer
transactions are undertaken at a large number of branches. The practice therefore is to calculate
the so-called “card rates” for customer transactions in the FX treasury in the morning, based on
the ruling rates in the domestic and international markets.

The card rates are then communicated to the operating branches by telephone or fax or e-mail
etc. The card rates are used for undertaking customer transactions for amounts not exceeding a
stipulated limit. Generally, the card rates are for relatively small value transactions, and are
difficult to change intra-day.

Card rate includes the maximum permissible margins. For large value transactions, i.e., beyond
the stipulated limits, the branches are expected to telephone the FX treasury and get applicable
rate. In general, these would be more competitive, and based on the ruling interbank rates.

 5. Interbank Forward Quotations:

These quotations are in paisa per dollar or any other foreign currency and apply to end of the
month deliveries. The interbank market is not active beyond 12 months. The interbank forward
quotations are quotes used and applied for transactions between two banks to ensure to remove
the mismatch of maturities in their forward transactions.

6. Cash: Spot and Call Rates:

The cash spot margin in the interbank market is generally governed by the call market in Indian
rupees. This is because arbitrage is possible between borrowings in the call market at a particular
rate, and sells cash or buy spot dollar swap in the exchange market. Banks would use the cheaper
market; hence, there is a strong correlation between the cash: spot margin and the call rate.
Q3). Why a Eurocurrency has limited scope of transaction as compare to dollar as a currency?
Discuss the advantages and limitations of Euro currency?

 Introduction:-

The Eurocurrency market is the money market for currency outside of the country where it
is legal tender. The Eurocurrency market is utilized by banks, multinational corporations, mutual
funds, and hedge funds. They wish to circumvent regulatory requirements, tax laws, and interest
rate caps often present in domestic banking, particularly in the United States. The term
Eurocurrency is a generalization of Eurodollar and should not be confused with the EU currency,
the euro. The Eurocurrency market functions in many financial centers around the world, not just
Europe. The Eurocurrency market originated in the aftermath of World War II when
the Marshall Plan to rebuild Europe sent a flood of dollars overseas. The market developed first
in London, as banks needed a market for dollar deposits outside the United States. Dollars held
outside the United States are called Eurodollars, even if they are held in markets outside Europe,
such as Singapore or the Cayman Islands.

The Eurocurrency market has expanded to include other currencies, such as the Japanese yen and
the British pound, whenever they trade outside of their home markets. However, the Eurodollar
market remains the largest. Interest rates paid on deposits in the Eurocurrency market are
typically higher than in the domestic market. That is because the depositor is not protected by the
same national banking laws and does not have governmental deposit insurance. Rates on
Eurocurrency loans are typically lower than those in the domestic market for essentially the same
reasons. Eurocurrency bank accounts are also not subject to the same reserve requirements as
domestic accounts.

 Definitions:-

 The Eurocurrency market is the money market for currency outside of the
country where it is legal tender.

 The term Eurocurrency is a generalization of Eurodollar and should not be

confused with the EU currency, the euro.

 There is also a Eurobond market for countries, companies, and financial

institutions to borrow in currencies outside of their domestic market.

 Eurocurrency markets can offer better rates for both borrowers and
lenders, but they also have higher risks.

Types of Eurocurrency Market

1. Eurodollar:-
Eurodollars were the first Eurocurrency, and they still have the most
influence. It is worth noting that U.S. banks can have overseas operations dealing in Eurodollars.
These subsidiaries are often registered in the Caribbean. However, the majority of actual trading
takes place in the United States. The Eurodollar trades mostly overnight, although deposits and
loans out to 12 months are possible. A 2016 study by the Federal Reserve Bank indicated that the
average daily turnover in the Eurodollar market was $140 billion. Transactions are usually for a
minimum of $25 million and can top $1 billion in a single deposit.

2. Euro yen:-
The offshore  euro yen market was established in the 1980s and expanded
with Japan's economic influence. As interest rates declined in Japan during the 1990s, the higher
rates paid by euro yen accounts became more attractive.

3. Eurobond:-
There is an active bond market for countries, companies, and financial
institutions to borrow in currencies outside of their domestic markets. The first such Eurobond
was issued by the Italian company Autos trade in 1963. It borrowed $15 million for 15 years in a
deal arranged in London and listed on the Luxembourg stock exchange. Issuing Eurobonds
remained popular in Italy, and the Italian government sold seven billion U.S. dollars in
Eurobonds in October 2019. It is essential to avoid confusing Eurobonds with euro bonds, which
are simply bonds denominated in Euros issued by countries or firms in the euro zone.

 Advantages of Euro Currency:-

1. Countries receive many benefits for adopting the euro. Smaller ones have the advantage
of being backed by Europe's powerhouse economies, Germany and France. 

2. The euro allows these weaker countries to enjoy lower interest rates. That's because the
euro wasn't as risky to investors as a currency with less demand from users and traders.

3. Over the years, these lower interest rates have led to more foreign investment. That
boosted the smaller nations' economies.

4. Some say the more developed countries reaped greater rewards from the euro. Their
larger companies could produce more at a lower cost, thus benefiting from economies of
scale.

5. They exported their cheap goods to the less-developed euro zone nations. Smaller
companies couldn't compete.

6. These larger companies also profited from investing cheaply in the less-developed
economies. That increased prices and wages in the smaller countries, but not the larger
ones. 

7. These larger companies also profited from investing cheaply in the less-developed
economies. That increased prices and wages in the smaller countries, but not the larger

 Disadvantages of Euro Currency:-

 1. With all these advantages, why haven't the remaining eight EU members adopted the
euro? Some countries are reluctant to give up some authority over their monetary and
fiscal policies when they join the euro zone.

2. Adopting the euro means countries also lose the ability to print their currency.

3. That ability allows them to control inflation by raising interest rates or limiting the money
supply.

4. They must keep their annual budget deficits less than 3% of their gross domestic product.

5.  Their debt-to-GDP ratio must be less than 60%.

6. Many simply haven't been able to cut spending enough to meet this criterion.

Q4).Write short note on:-

1. Purchasing power parity:-

 Introduction:-

One popular macroeconomic analysis metric to compare economic productivity and standards
of living between countries is purchasing power parity (PPP). PPP is an economic theory that
compares different countries' currencies through a "basket of goods" approach. According to this
concept, two currencies are in equilibrium known as the currencies being at par when a basket of
goods is priced the same in both countries, taking into account the exchange rates.

To make a meaningful comparison of prices across countries, a wide range of goods

and services must be considered. However, this one-to-one comparison is difficult to achieve due
to the sheer amount of data that must be collected and the complexity of the comparisons that
must be drawn. To help facilitate this comparison, the University of Pennsylvania and the United
Nations joined forces to establish the International Comparison Program (ICP) in 1968.

With this program, the PPPs generated by the ICP have a basis from a worldwide price
survey that compares the prices of hundreds of various goods and services. The program helps
international macroeconomists estimate global productivity and growth.

Every three years, the World Bank releases a report that compares the productivity and
growth of various countries in terms of PPP and U.S. dollars. Both the International Monetary
Fund (IMF) and the Organization for Economic Cooperation and Development (OECD) use
weights based on PPP metrics to make predictions and recommend economic policy. The
recommended economic policies can have an immediate short-term impact on financial markets.
Also, some forex traders use PPP to find potentially overvalued or undervalued currencies.
Investors who hold stock or bonds of foreign companies may use the survey's PPP figures to
predict the impact of exchange-rate fluctuations on a country's economy, and thus the impact on
their investment.

 Definitions:-

 Purchasing power parity (PPP) is a popular metric used by macroeconomic analysts that
compares different countries' currencies through a "basket of goods" approach.
 Purchasing power parity (PPP) allows for economists to compare economic productivity
and standards of living between countries.
 Some countries adjust their gross domestic product (GDP) figures to reflect PPP.
 Meaning:-

Every three years, the World Bank releases a report that compares the productivity
and growth of various countries in terms of PPP and U.S. dollars. Both the International
Monetary Fund (IMF) and the Organization for Economic Cooperation and Development
(OECD) use weights based on PPP metrics to make predictions and recommend economic
policy. The recommended economic policies can have an immediate short-term impact on
financial markets.

Also, some forex traders use PPP to find potentially overvalued or undervalued

currencies. Investors who hold stock or bonds of foreign companies may use the survey's PPP
figures to predict the impact of exchange-rate fluctuations on a country's economy, and thus the
impact on their investment.

 Types:-

Every three years, the World Bank releases a report that compares the productivity and growth of
various countries in terms of PPP and U.S. dollars. Both the International Monetary Fund (IMF)
and the Organization for Economic Cooperation and Development (OECD) use weights based on
PPP metrics to make predictions and recommend economic policy. The recommended economic
policies can have an immediate short-term impact on financial markets. Also, some forex traders
use PPP to find potentially overvalued or undervalued currencies. Investors who hold stock or
bonds of foreign companies may use the survey's PPP figures to predict the impact of exchange-
rate fluctuations on a country's economy, and thus the impact on their investment.

Drawbacks of Purchasing Power Parity:-

Since 1986, The Economist has playfully tracked the price of McDonald's Corp.’s (MCD) Big
Mac hamburger across many countries. Their study results in the famed "Big Mac Index".
In Burgernomics a prominent 2003 paper that explores the Big Mac Index and PPP authors
Michael R. Pakko and Patricia S. Pollard cited the following factors to explain why the
purchasing power parity theory is not a good reflection of reality.
 Transport Costs:-
Goods that are unavailable locally must be imported, resulting in transport costs. These costs
include not only fuel but import duties as well. Imported goods will consequently sell at a
relatively higher price than do identical locally sourced goods.

Tax Differences:-

Government sales taxes such as the value-added tax (VAT) can spike prices in one country,
relative to another.

Government Intervention:-

Tariffs can dramatically augment the price of imported goods, where the same products in other
countries will be comparatively cheaper.

Non-Traded Services:-

The Big Mac's price factors input costs that are not traded. These factors include such items as
insurance, utility costs, and labor costs. Therefore, those expenses are unlikely to be at parity
internationally.

Market Competition:-

Goods might be deliberately priced higher in a country. In some cases, higher prices are because
a company may have a competitive advantage over other sellers. The company may have a
monopoly or be part of a cartel of companies that manipulate prices, keeping them artificially
high.

The Bottom Line:-

While it's not a perfect measurement metric, purchase power parity does allow for the possibility
of comparing pricing between countries that have differing currencies.

2. Write short note on components of capital structure of multinational firms:-

 Introduction:-

Multinational corporations leverage their financial position and access to global markets to raise
capital in a cost-effective and efficient manner. This gives these companies an advantage over
small domestic operators that do not have the same level of credit or cash, but there are risks
associated with international finance. The capital structure multinationals use directly impacts
profitability, growth and sustainability.

 Factors:-

1. Invested Capital:-
A multinational’s capital structure comprises the sources of money used
to finance operations, expand production or purchase assets. Companies acquire capital through
the sale of securities in financial markets such as the New York Stock Exchange or the London
Stock Exchange. Debt and equity are the two forms of capital that multinationals have to choose
from, and each form has its advantages and disadvantages. The cost of raising capital is an
important component of financing decisions.

2. Debt Financing:-
Acquiring debt capital is a process that is contingent on the availability of funds in the global
credit markets, interest rates and a corporation’s existing debt obligations. If credit markets are
experiencing a contraction, it may be difficult for the corporation to sell corporate bonds at
favorable rates. In particular, it may be challenging to get high advance rates for asset-backed
securities. If a firm becomes over-leveraged, it may be unable to pay its debt obligations leading
to insolvency. However, debt costs less to acquire than other forms of financing.
3. Equity Financing:-
Preferred stock, common stock and components of retained earnings are considered equity
capital. It is important for a multinational to carefully analyze its equity cash flows and mitigate
the risk associated with currency fluctuations. Otherwise, it may lose equity due to changes in
exchange rates. Also, the issuance of new shares may cause stock prices to fall because investors
no longer feel company shares are worth their pre-issuance price. Offering stock in global
financial markets costs multinationals more than acquiring debt, but it may be the right financing
option if a corporation is already highly leveraged.
4.Tax Considerations:-
Multinationals have the option to shift income to jurisdictions where the tax treatment is the most
advantageous. As a result, debt and equity financing decisions are different relevant to solely
domestic companies. If income is reported in the United States, it may be beneficial to obtain
debt financing, because the interest is tax-deductible. When making capital structure decisions,
multinationals must evaluate their tax planning strategies to minimize their tax liabilities.