Prof.CA.Rudramurthy.

BV
CA, M.COM, MFM, M-PHIL, PGDBA, PGDMM.
For Further details CONTACT 9845620530 / 9886842254
II SEM FM CRASH COURSE STARTING FROM 16 TH
MAY 2009.
International Financial Management:
International financial management is
concerned with Capital structure,
Investment and Dividend Decisions of a
Multinational firm.
It is the process of integrating the finance
functions of parent company in the home
country and its subsidiary in the host
country so as to maximize the wealth of the
shareholders given the risks associated with
international business.
2
International Financial Management:
International financial management refers
to global decisions taken in the context of
cross border transactions so as to maximize
the wealth of shareholders keeping in mind
the international risk associated with such
international transactions.

3
Importance of IFM:
Study if international finance is important for
the following reasons:
1. Currency risks involved in International
business.
2.Study of host countries policies towards
Multinational companies.
3. Opportunity to tap resources like raw-materials,
labour etc cheaply and effectively.
4.Expansion and Diversification of business.
5.International sources of funds. 4
Differences between Domestic and
International Financial Management:
1. Domestic FM is single currency denominated
whereas International FM is multiple currency
denominated.
2. Domestic FM has to face the risk of single
countries Political system whereas
Multinational firms have multiple political
risks to manage.
3. Domestic FM has limited sources of funds to
raise unlike International FM where funds can
be raised through GDR, ADR, Euro Bonds etc.
5
Differences between Domestic and
International Financial Management:
4. Domestic FM has limited scope for mitigating
its risk whereas International FM has vide
variety of risk mitigating techniques using
various derivative instruments and other
techniques.
5. Domestic FM has a limited cultural and
language shocks compared to International FM.
6. The legal systems of Domestic FM and
International FM differs due to home country
and host country disparities.
6
Differences between Domestic and
International Financial Management:
7. Domestic FM is concerned with Domestic
Accounting standards (Ex: For India, Indian
Accounting Standards) whereas International FM
is concerned with Global Accounting Standards
like GAAP’s, IFRS etc.
8. The area of operation of a Domestic FM is much
Limited compared to that of International FM.
9. Domestic FM has limited scope of resources for
various factors of production whereas International
FM has a multiple resource belt from where Co’s
can raise resources cost effectively.
7
Differences between Domestic and
International Financial Management:
10. Domestic FM has no Translation exposures
whereas International FM results in Translation
exposures.
11. Domestic FM is regulated by the law of the
country whereas International FM is regulated
by International Unions and organizations like
World Banks, IMF etc.
12. Study of Economic Conditions like Growth,
Inflation, Interest rates etc prevalent in
International FM is more complex than
Domestic FM. 8
IFM ENVIRONMENT:
The Scope of International Finance widens
due to its peculiarities in operations such as:
1. International Monetary System.
2.International Sources of funds.
3.International Financial Institutions.
4.International Taxation systems.
5.International Political setup.
6.Differing treatment to Host and Domestic
corporates. 9
Scope of IFM:
The scope of International finance can be
studied under three broad categories namely:
I. FINANCING DECISIONS.
II.INVESTMENT DECISIONS.
III.WORKING CAPITAL MANAGEMENT
DECISIONS OR MONEY MANAGEMENT
DECISIONS.

10
FINANCING DECISIONS:
It refers to raising the required capital
through the best combination of
International Equity and Debt in the best
possible combination so as to reduce the
overall cost of capital.
Various sources of raising funds:
include(Refer chapter 5 for explanation)
I. Equity Instruments.
II.Debt Instruments.
11
INVESTMENT DECISIONS:
Investment Decisions in a global scenario is
taken considering the International Capital
Budgeting techniques.
Various Investment risk involved in
multinational scenario like Political,
Economic, Commercial etc should be
considered before making International
Investment Decisions.

12
INVESTMENT DECISIONS:
The various factors considered for
International Capital budgeting include:
a)Life of the Project.
b)Cash Flows associated with the projects.
c)Exchange rates.
d)Discount factor.
e)Terminal or Salvage value.
f)Income tax and Withholding tax.
g)Financing availability in host country etc.
13
WORKING CAPITAL MANAGEMENT DECISIONS:
It is concerned with the decision of a multinational
company on the combination of current assets and
current liabilities that will maximize the value of
the firm.
It includes areas such as:
1. International Cash Management.
2. International Receivable or Debtors Management.
3. International Inventory Management.
4.International Creditors or Suppliers Management.

14
Significance of IFM:
In this globalised economy where the entire
globe is considered as one single country,
study of international finance is highly
significant and a must for the survival of
Corporate entities due to the following
reasons:
1) To undertake International Business
opportunities.
2) To understand the effect of exchange rates
on the companies. 15
Significance of IFM:
3) To understand the changes in International
Accounting standards and reporting
requirements .
4) To raise finance through global sources of
Equity and Debt.
5) To know the impact of policies taken by
International financial institutions such as
IMF or world banks on our economy as
general and corporate in specific.
16
Significance of IFM:
6) To learn international ways of hedging in
International derivative markets.
7) To understand the Political situations and
decisions in Global world.
8) To tap resources globally at effective prices.
9) For expansion and diversification of
business.
10) To learn International Working capital
decisions.
17
Finance Function:
Finance function in a multinational firm can
be broadly classified into 2types namely:
Treasurer Function.
Accounting and Control Function.

Both these functions are to be studied in

totality and not in isolation as decisions taken
by treasurer affects the controller and vice-
versa.
18
Treasurer Function:
 Treasury function is concerned with
acquisition and allocation of financial
resources so as to minimize the cost and
maximize the return consistent with the
level of financial risk acceptable by the
firm.

19
Treasurer Function:
Treasurer functions include:
1. Financial Planning analysis.
2. Fund acquisition.
3. Investment Decision.
4. Working Capital management decisions.
5. Risk Management.

20
Accounting and Control Function:
 Accounting and Control Function
include:
1. External Reporting.
2. Financial & Management Accounting.
3. Tax Planning and Management.
4. Budget Planning and Control.
5. Management Information System.
21
Institutional structure of IF Markets:
 Euro Dollar Deposit Vs Offshore currencies:
Euro Dollar deposits refers to US Dollar
denominated bank deposit outside the US.
Offshore currencies are generalized form of
Euro Dollar deposit which includes not only
Euro Dollar Deposit but also other externally
held foreign offshore currencies such as Euro
Sterling deposit, Euro Yen deposit etc.

22
Institutional structure of IF Markets:
Thus Offshore currency markets ensure
single point solution to all types of currency
needs and there is no need to go different
currency centers to arrange deals.
Different types of Offshore currency
Instruments include:
1. Offshore term Deposits with fixed term such
as 30 days or 90 days and are not negotiable.
2. Offshore currency deposits denominated in
Special drawing rights. 23
Institutional structure of IF Markets:
3. Offshore currency deposits in the form of
Certificate of Deposits which are negotiable
instruments that can be traded in the secondary
markets.
 Offshore banks are well hedged by having
sufficient assets in the currencies in which they
accept deposits. Thus they balance both sides of
their accounts with equal volumes and maturities
of assets and liabilities in every foreign currency so
as to safeguard itself from exchange rate changes.
24
International Instruments:
Letter of Credit:
 A Letter of credit is an instrument acting as
a guarantee by the buyers bank on payment for
goods or service delivered on satisfaction of all
the terms and conditions given in the letter of
credit and on presentation of all relevant
documents in exact conformity.
The importer’s banker will issue letter of
credit only on satisfaction of importers
creditworthiness. 25
International Instruments:
Letter of Credit:
 The importers banker can ask for collateral
if it is not satisfied with the importer
creditworthiness.
 The above service comes for a fee, which Is
borne generally by the importer in full.
 A copy of letter of credit will be sent to
branch of importers banker in sellers
destination.
26
International Instruments:
Letter of Credit:
 That bank in turn informs the exporters
bank which will in turn inform the exporting
company.
 On receipt of letter of credit, the exporter
starts producing and preparing for the goods
to be exported as he is assured of the payment
by the issuing bank of letter of credit.

27
International Instruments:
Letter of Credit:
 The actual payment will be made in the
form of draft or bill of exchange drawn by the
exporter and sent to importers bank for
acceptance. It is sent directly or through the
exporters bank.
 On satisfaction of various necessary
documents in conformity will the terms of
letter of credit, the importers bank accepts the
bill by stamping and signing across the same. 28
International Instruments:
Letter of Credit:
Before acceptance, the acceptor banker demands
for bill of lading or airway bill as the most important
document entailing the ownership of goods.
The Exporter can discount or endorse the accepted
draft based on the quality and credit rating of the
issuing banker at a cost for the short term financing
requirement.
 Instead the Exporter may even chose to hold the
bill till maturity and then collect the entire receivable
on maturity.
29
International Instruments:
Letter of Credit:
 The Importers bankers branch in exporter
destination will forward the documents to the
exporters banks branch and the importer should
make payment to his bank which issued the letter
of credit based on the forward hedge taken by the
importer or settlement on the due date.
 After receiving the sum due from the importer,
the bank hands over the various documents
collected from the exporter to importer who in turn
can take delivery of the imported goods. 30
International Instruments:
Letter of Credit:
 Importer would have made payment to the
issuing bank branch in his country, which in
turn would have made payment to its branch
in Exporters country, which in turn will make
payment to Exporters banker and who in turn
will credit the exporters account.
 Letter of credit is a documentary credit as it
requires many documents to be presented for
its honour. 31
International Instruments:
Clean credit Vs Documentary credit:
Letter of credit is a documentary credit as it
requires many documents to be presented for
its honour.
Whereas Clean credit does not require
presentation of any document and it is issued
only when there exists complete trust and
where goods are transferred from one
subsidiary to another of the same company.
32
Other International Instruments:
Open Account:
The importer can avoid the expenses of letter
of credit (Bankers fee) through an open account
if the Exporter and Importer have long term
relationships.
An Open account is a simple credit
mechanism (Debtors) where the importers
account is debited in the books of exporter and
exporters account is credited in the books of
importer and payment is made on the due date.33
Other International Instruments:
Consignment Sales:
In case of Consignment sale, the importer just
acts as an agent of exporter and remits all
receipts of goods sold to the exporter after
holding his margin.
The advantage of Consignment sale to the
Exporter is that the title of goods always
remains with him.

34
Other International Instruments:
Cash in Advance:
In case importer being a stranger and where
the exporter doubts the creditworthiness of
importer, then he might prefer cash in advance.
Under this case, importer has to make
payment in advance even before the goods are
shipped to him.

35
Other International Instruments:
Export Insurance:
In case of exporter demanding only Letter of
credit, due to competition from other exporting
units he may lose the sale.
Thus he can hedge his Political and
Commercial Risk by buying a Export Credit
insurance covering either both risks or any one.
However the coverage of Export insurance
unlike letter of credit is not in full and it is only
after a deductible. 36
Financing of International trade:
 Exporter can avail short term credit on his
credit sale in the following ways:
1. Discounting the trade draft accepted by the
Importer. (Higher discount rate)
2.Discounting the Letter of credit - Draft
accepted by the banker. (Lower discount rate)
Generally a letter of credit is issued for 30, 60,
90 or 180 days.

37
Financing of International trade:
3. Forfaiting:
 Forfaiting is a medium term non recourse exporter
arranged financing of importers credits.
 It is a form of medium term financing which involves
discounting by the forfaiting bank a series of
promissory notes due for a period of 6months intervals
ranging for 3 to 5years signed by an importer in favour
of the exporter. These instruments gain value and are
liquid as it is guaranteed by the importers bank.
 These notes may be held by the forfaiting bank till
maturity or even sold to another investor.
38
Financing of International trade:
 Unlike trade drafts discounted, forfaiting is an
non recourse instrument where the exporter is
not liable for non payment by importer.
 Thus the cost of forfaiting is generally higher
compared to discounting of drafts since there
exists no recourse from exporter.
The cost of forfaiting depends upon the
denominated currencies strength, terms of the
notes, credit rating of the issuer, commercial and
political risk of the importer and his country.
39
Financing of International trade:
4. Financing by Government Agencies of Home
country:
As exports bring foreign currency inflows to the
host country, the Government of host country
finances various short term, medium term and
long term needs of the exporter through its EXIM
Banks and other agencies.
Government also does indirect financing by
providing funds to local financial institutions
which in turn provide loans to exporters.
40
Financing of International trade:
5. Private Export Funding Corporation (PEFC):
 It is a private lending organisation started by a
group of commercial banks and large export
manufacturers.
These PEFC finances international trade
through its sources of funds raised by sale of
foreign repayment obligations and secured notes
on the security markets.

41
Institutions regulating International trade:
 The two most important arrangements
involving the regulation of international
trade and its conduct are:
1. World Trade Organisation.
2.Free Trade areas.

42
World Trade Organizations:
 The World Trade Organization (WTO) is the
only global international organization dealing
with the rules of trade between nations.
At its heart are the WTO agreements, negotiated
and signed by the bulk of the world’s trading
nations and ratified in their parliaments.
The goal is to help producers of goods and
services, exporters, and importers conduct their
business as smoothly, predictably and freely as
possible.
43
Functions of WTO:
 Administering trade agreements.
Acting as a forum for trade negotiations.
Settling trade disputes.
Reviewing national trade policies.
 Assisting developing countries in trade
policy issues, through technical assistance
and training programs.
Cooperating with other international
organizations.
44
Structure of WTO:
 The WTO has 153 members, accounting for
over 97% of world trade. Around 30 others
are negotiating membership.
Decisions are made by the entire
membership typically by consensus.
The hierarchy of WTO consists of
ministerial conference which is the top most
decision making body and below it we have
General Council, Goods Council, Service
Council and Intellectual Property Council. 45
Brief Summary of WTO:
Location: Geneva, Switzerland
Established: 1 January 1995
Created by: Uruguay Round negotiations (1986-94)
Membership: 153 countries.
Budget: 189 million Swiss francs for 2009
Secretariat staff: 625
Head: Director-General, Pascal Lamy.

46
Differences b/w GATT and WTO:
WTO is not an extension of GATT but it is a
succession to GATT. The main differences are:
GATT has no legal status whereas WTO has a legal
status.
GATT had a set of rules and regulations which
were of selective nature and were not binding on
all members whereas WTO has rules and
regulations which are mandatory and binding on
all members.
GATT discussion were not time bound unlike
WTO which is time bound. 47
Differences b/s GATT and WTO:
The WTO is a chartered trade organisation
unlike GAAT which was a secretariat.
WTO has extended its coverage even to aspects
of Intellectual Property rights (TRIPS) which
was not under the ambit of GATT.
WTO has a better dispute settlement function
compared to GATT since agreements cannot be
blocked for reason of failure to achieve
consensus.

48
Free Trade areas and Custom Unions:
 In case of free trade areas, Tariffs are removed
on trade among members whereas they have
their own systems of tariffs for non member
countries trade which are differential in
nature.
Ex: NAFTA – North American Free Trade
Agreement.

49
Free Trade areas and Custom Unions:
Custom Unions are similar to free trade areas
except for common tariff to all non member
countries.
European Union is a Custom Union set up in
Jan 1993 which has 27 members till date.
It is the largest custom union till date.
Companies operating outside the European
Union as to face competition with firms inside
the European Union that have favourable
terms when traded within the members. 50
Euro Equity issue:
 An Euro Equity issue refers to shares issued
outside the home country.
Ex: If a Non US based Co issues shares in US or
if a US based Co raises equity funds outside
US, then it is known as Euro Equity Issue.
Considerations in Euro Equity issue include:
1. Selecting the country in which stock should be
issued based on the best price for the stock
where a Company can get on its shares net of
issuance cost.
51
Euro Equity issue:
2. The vehicle of share issue i.e. whether the
issue should be done by the Parent or by the
Subsidiary.
Tax considerations may motivate use of
specially established financing subsidiary to
avoid withholding tax on payments made to
foreigners.

52
SOURCES OF FUNDS:
I. Equity Instruments in International Market:
1.Depositary receipt is a type of negotiable
financial security that is traded on a local
stock exchange but represents a security,
usually in the form of equity, that is issued by
a foreign publicly listed company.

53
SOURCES OF FUNDS:
1.a).Global depository receipts(GDR)
represents the shares traded in various local
stock exchanges around the world (such as NSE
and BSE in India, Nikkie in Japan, Hongkong
stock exchange in China, New York stock
exchange in America, London Stock exchange in
Europe)issued by foreign public listed company.
The global depository receipts will be traded all
over the world expect the issuing country.

54
SOURCES OF FUNDS:
1.b). An American Depositary Receipt (ADR)
represents the ownership in the shares of a
foreign company trading on US financial
markets. The stock of many non-US companies
trades on US exchanges through the use of
ADRs. ADRs enable US investors to buy shares
in foreign companies without undertaking
cross-border transactions. ADRs carry prices in
US dollars, pay dividends in US dollars, and can
be traded like the shares of US-based
companies.
55
SOURCES OF FUNDS:
II. DEBT/BOND Instruments:
1. Euro Bonds:
Euro bond is issued outside the country of
the currency in which it is denominated. It is
like any other Euro instrument and through
international syndication and underwriting,
the paper can be sold without any limit of
geographical area.

56
SOURCES OF FUNDS:
2. Foreign Bonds:
a) Yankee Bonds: These are US dollar
denominated issues by foreign borrowers
(Non US borrowers) in US Bonds markets.
Usually foreign government or entities,
supernationals and highly rated corporate
borrowers issue yankee bonds.

57
SOURCES OF FUNDS:
DEBT Instruments:
2. Foreign Bonds:
b) Samurai Bonds: These are bonds issued by
Non-japanese borrowers in domestic
Japanese markets with a maturity varying
over 3 to 20 years. The borrowers are
supernationals and have at least a minimum
investment grade rating (A Rated)

58
SOURCES OF FUNDS:
DEBT Instruments:
2. Foreign Bonds:
c) Bull dog Bonds: These are sterling denominated
foreign bonds which are raised in the UK domestic
securities market. The maturity of these bonds
vary from 5 to 25 years. These bonds are
subscribed by the long term institutional investors
like pension funds and life insurance companies.
These bonds are redeemed on bullet basis (one
time lump sum payment on maturity.)
59
SOURCES OF FUNDS:
DEBT Instruments:
2. Foreign Bonds:
d) Shibosai Bonds: These are privately placed
bonds issued in the Japanese markets. The
qualifying criteria is less stringent as
compared to Samurai or Euro Yen bonds.
Shibosai bonds are offered to a different set
of investors such as institutional investors
and banks.
60
SOURCES OF FUNDS:
3. Euro Notes:
Euro notes are the short term instruments
and the return on these instruments are
based on the varying bench mark LIBOR.
The funding instruments in the form of
Euro notes possess flexibility and can be
tailored to suit the specific requirements of
different types of borrowers.

61
SOURCES OF FUNDS:
4. Euro Credit Syndication:
It is a private arrangement between the
lending banks and borrowers. Lending
banks join together and advance the loans to
the borrower.

62
SOURCES OF FUNDS:
5. Parallel Loans:
A Parallel loan involves an exchange of funds
between firms in different countries with the
exchange reversed on a future date.
Ex: If a US Company subsidiary in Canada
needs C$ and a Canadian Company subsidiary
in US needs US$, the Canadian firm can lend C$
to US subsidiary and US firm can lend US$ to
Canadian Subsidiary. After an agreed term, the
funds can be repaid.

63
SOURCES OF FUNDS:
6. Credit Swaps:
It involves exchange of currencies between
a bank and a firm wherein the parent makes
a deposit of local currency in a bank and the
bank instructs its branch in the country
where the subsidiary is situated to make
payment in foreign currency to the
subsidiary.

64
SOURCES OF FUNDS:
7. Government and Development bank
lending:
The Government of host country provides
necessary finance to the foreign affiliate if
the project generates necessary jobs, earn
foreign exchange and provide training for
their citizens. International development
agency (IDA) and International Finance
Corporation (IFC) are affiliate of world
banks which provide financial assistance.
65
INTERNATIONAL CAPITAL BUDGETING:
It is a long term investment decision
concerned with international long term
projects.
It refers to investment decision on fixed
assets concerned with foreign projects.
It is the process by which the financial
manager decides whether to invest in
specific capital projects or assets across the
boundaries of the domestic country.
66
IMPORTANCE OF INTERNATIONAL CAPITAL
BUDGETING:
Heavy expenditure
Long duration
Irreversible of decision making
Complexity of decision making
Direct impact on organization
Currency fluctuation

67
Differences between Domestic and
International Capital budgeting:
Exchange rate fluctuations causes change in
estimated cash flow in case of international
capital budgeting.
The government of host country (foreign
country) may impose withholding tax for
funds remitted by the subsidiary company to
the parent company.
A portion of international project financing
can be done by borrowing funds from a
bank in host country. 68
Differences between Domestic and
International Capital budgeting:
Ascertainment of expected salvage value due
to early divestment may result in change in
cash flow.
Corporate tax rate differs from home country
to host country.
Estimated exchange rates for future is
uncertain.
Political conditions, social set up and
economic conditions in the home country
and host country may differ. 69
TECHNIQUES OF CAPITAL BUDGETING:
There are two techniques or methods of
International Capital Budgeting:
Methods which do not consider time value
of money.
Methods which do consider time value of
money.

70
Methods which do not consider time value
of money:
1. PAY BACK PERIOD:
It is a period within which we get our initial
investment.
PBP = initial investment
uniform annual cash inflow

71
Methods which do not consider time value
of money:
2. PAY BACK RECIPROCAL:
It is a reciprocal of pay back period
PBR = uniform cash inflow * 100
initial investment
Interpretation: higher the pay back
reciprocal, better the proposal

72
Methods which do not consider time value
of money:
3. POST PAY BACK PERIOD:
Life of project – pay back period
Interpretation: higher the PPBP, better
the proposal.

73
Methods which do not consider time value
of money:
4. POST PAY BACK PERIOD:
ARR = Average Profit * 100
Initial Investment
Average profit= Total PATAD
life of project 
Interpretation: higher the ARR, better
the proposal.
74
Methods which do consider time value of
money:
1. NET PRESENT VALUE METHOD:
NPV = Total of PV of Cash Inflows - Total of
PV of Cash Outflows.
Higher the NPV better the proposal.

75
Methods which do consider time value of
money:
2. INTERNAL RATE OF RETURN:
It is at that rate of return at which the PV of
total cash inflows = the PV of total cash
outflows.
It is at that rate of return at which NPV =
Zero.
If IRR is > Cost of Capital accept the project
or else reject it.
76
Methods which do consider time value of
money:
3. PROFITABILITY INDEX OR BENEFIT
COST RATIO:
PI = Total of Discounted Cash Inflows
Total of Discounted Cash Outflows
PI of 1 or above 1 shall be preferred.
Higher the PI, better the proposal.

77
Methods which do consider time value of
money:
4. DISCOUNTED PAY BACK PERIOD:
DPBP = Discounted Annual Cash Inflows
Initial Investment
Lower the DPBP better the proposal.
DPBP is same as PBP except it considers
time value of money which is not considered
by PBP.

78
FOREIGN DIRECT INVESTMENT:
FDI refers to investment of foreign assets into
domestic structures, equipment and organisations.
FDI occurs when an organisation in a foreign
country gains sufficient interest of at least 10% or
more control on the domestic assets.
A cross border investment in which the resident in
one country acquires a lasting interest in an
enterprise in another economy.
FDI can be either in the form of Green Field
Investment or Acquisition/Merger.
79
FACTORS RESPONSIBLE FOR GROWTH OF FDI:
Pressure of competition in Domestic country.
To benefit from economies of scale.
Product Imperfection.
Market Imperfection.
Market Opportunities.
Imperfect Raw-materials.
Imperfect labour markets.
Better technology in foreign markets.
Foreign exchange rates.
80
FACTORS RESPONSIBLE FOR GROWTH OF FDI:
Imperfect financial markets resulting in
better raising of funds globally.
Imperfect financial instruments.
Imperfect financial system.
Imperfection in financial intermediaries.
Better demand for product.
Product differentiation.

81
FDI ADVANTAGES TO HOST COUNTRY:
Increases import capacity.
Increase Productivity and efficiency.
Stimulate better economic activity.
Better utilisation of capacity.
Foreign flows to country helping it in better
reserves.

82
FDI DISADVANTAGES TO HOST COUNTRY:
Increases competition in domestic markets.
Loss of control to foreign corporates.
Higher Imports.
Negative Impact on small and medium sized
domestic corporates.
Unfair competition and exploitation of local
resources.

83
FDI ADVANTAGES TO HOME COUNTRY:
Increases income and profit levels.
Expansion and Diversification.
Lower cost of access to resources.
Portfolio diversification.
Better use of technology.

84
FDI DISADVANTAGES TO HOME COUNTRY:
Language and cultural barriers.
Cost of international movement of
resources.
Poor knowledge of local conditions.
Disparity in Political system and legal
control.
Differential tax systems and jurisdiction.

85
International Cost of Capital:
A firm’s weighted average cost of capital is
the total cost of financing by taking the
weight age of the percentage of financing
from each source of capital. Thus, when a
firm has both debt and equity in its capital
structure, its financing cost can be
represented by the weighted average cost of
capital. This is computed by considering cost
of equity and after tax cost of debt.
KA = Wd [Kd(1-t)] + We(Ke).
86
Cost of capital of MNCs Vs Domestic Firms:
The reasons for the differences in cost of capital for
an MNC from that of fully established domestic
firm are:
1. Size of the firm:
Firms which operate at international level borrow
huge capital at lower cost when compared to that of
local domestic firms. MNCs also have the
opportunity to borrow form that place where cost of
capital is low. Therefore, MNCs will be able to get
lower cost of capital when compared to that of
domestic firms.
87
Cost of capital of MNCs Vs Domestic Firms:
2. Foreign Exchange Risk:
MNCs are subject to foreign exchange risk. The
share holders demand higher dividend when there
exists more foreign exchange. This results in the
increase in the cost of capital of MNCs.
3. International Diversification Effect:
MNCs operate in diversified operations which helps
them to reduce their cost of capital. It also enjoys
the stability of cash flows because of diversified
operations.
88
Cost of capital of MNCs Vs Domestic Firms:
4. Access to international capital markets:
The MNCs have access to international capital
markets. This is an advantage as the firms can
attract funds from international markets. And the
subsidiary which is established in the home country
can also attract funds from the local market if the
funds are cheap.
5. Country Risk analysis:
Country risk refers to the exposure to loss in cross-
border lending caused by Political and Economic
events.
89
Cost of capital of MNCs Vs Domestic Firms:
6. Tax concessions:
MNCs choose those countries where the tax laws
are favourable for them. This is very important
because their net income substantially depends on
the tax policies.

90
International Capital structure:
Capital structure refers to the financing the firm
with the combination of debt and equity. The overall
capital structure of MNC refers to the combination
of all its subsidiaries capital structure. The debt is
the cheaper source of capital when compared to
equity. The increase of debt in the capital structure
decreases the cost of capital to some extent. It the
debt is increased over and above the maximum level
of debt, the share holders demand higher return on
equity to set off against the risk of bankruptcy
because of higher debt. This again results in higher
cost of capital. 91
International Capital structure:
The trade off between the debts advantage (low
cost of capital because of tax deductibility of
interest) and its advantage (increases the
probability of bankruptcy) is illustrated in the
following diagram. Initially the cost of capital
decreases as the debt increases to some extent.
After some point, the cost of capital rises as the
ratio of debt to total capital increases.

92
COUNTRY RISK ANALYSIS:
Assess the firm in subsidiary investment or
divestment decision based on analysis of
various political economic risk factors
 it is a continuous process of monitoring
various factors that affects the risk analysis of
a particular country

93
COUNTRY RISK ANALYSIS:
I. Political risk assessing factors:
Stability of local political environment
Consensus regarding priority
 attitude of host government
War & terrorism
Major changes in political system

94
COUNTRY RISK ANALYSIS:
II. Economic risk assessing factors:
Inflation rate
Growth rate
National human and financial capital
Adjustment external shock
Degree of dependency and independency
with other nation

95
Techniques to assess country risk analysis:
Debt servicing capacity.
Bop assessment.
Economic indicator analysis.
Checklist method.

96
Managing Political Risk:
Finance the subsidiary with local capital.
Structure operations so that the subsidiary
has value only as a part of the integrated
corporate system.
Obtain insurance against risk.

97
International Working Capital Management:
International Working Capital
management is the process of managing
short term international financial
transactions.
It is the process of determining the amount
of liquidity required by MNC’s and the form
in which it should be constituted and
proportioned.

98
International Working Capital Management:
It is the process of planning and controlling
the level and mix of current assets of the
firm as well as financing of these assets
through various current liabilities.
International working capital management
includes managing of international cash
transactions, inventory management and
receivable management.

99
Objectives of International W/C mgt:
To determine the optimal amount of investments
in various current assets.
To minimize the investments in current assets.
To match the short term fund requirement with
various combination of short term funds.
To allocate short term investment and cash
balance holdings between currencies and
countries to maximize overall corporate returns.
To borrow in various money markets and to
achieve minimum cost of borrowing.
100
Factors affecting international W/C requirements:
Nature of business.
Production policy.
Lead time.
Currency fluctuation.
International tax regulation.
Govt. Rules and regulations.
Accessibility to credit.
Dividend Policy.
Cost of Capital.
101
International Cash Management:
International Cash Management refers to cross
border movement of funds from and to other
companies as well as within the company.
Basic principles of International Cash
management include:
a)Having a Cash mgt center that receives and
distributes timely information relating to cash
movement in international scenario.
b)Use of modern communication system.
c)To have minimum banks and maximum control.
102
Objectives of International Cash Management:
To allocate necessary cash to the required
areas at proper quantity and time.
To maximize return on investment.
To ensure lower transaction cost.
To fasten transfer of funds from one place
to another.
To minimize borrowing cost.
To minimize currency exposure risk.
To minimize country and political risk.
103
Centralized Vs Decentralized Cash Management:
Centralized Cash Management refers to
managing of international short term
resources from one place, preferably the
head office.
Decentralized Cash Management involve
management of short term funds at branch
or departmental level.

104
Centralized Cash Management:
A centralized cash management group is
needed to monitor and manage the parent/
subsidiary and inter subsidiary cash flows.
Centralization refers to centralization of
information, reports and the decision
making process as to cash mobilization,
movement and investment outlets.

105
Advantages of Centralized Cash Management:
Maintaining minimum cash balance during
the year.
Helping the centre to generate maximum
possible returns by investing all cash resources
optimally.
Judiciously manage the liquidity requirements
of the centre.
Helping the centre to take complete advantage
of multinational netting so as to minimize
transaction costs and currency exposure.
106
Advantages of Centralized Cash Management:
Optimally utilize the various hedging
strategies so as to minimize the MNCs
foreign exchange exposure.
Achieve maximum utilization of the
transfer pricing mechanism so as to enhance
the profitability and growth by the firm.

107
Dis-Advantages of Centralized Cash Management:
Delay in decision making.
Loss of sales.
Autocratic management.
Lacks worker involvement etc.

108
De-Centralized Cash Management:
It is a system where the branch head is
given an authority to deal with cash inflow
and cash payments.
The advantages of Centralized system
becomes disadvantages of De-Centralized
system and vice-versa.
A thorough Cost – Benefit analysis should
be done before deciding the system of cash
management.
109
Techniques to optimize cash flow:
Accelerating cash inflows: It refers to the
quick recovery of the cash flows. Various
innovative measures and new technologies
and banking system helps in maintaining
the system to accelerate the cash flows.
Managing blocked funds: Some times the
host Government insists the subsidiary to
invest the income in the host country itself.
This increases the pay back period of the
MNC.
110
Techniques to optimize cash flow:
Leading and lagging strategy:
Leading and lagging involves an adjustment
in the timing of the payment or
disbursement to reflect expectations about
the future currency movements.
Leading means fastening (Paying or
receiving early) and lagging means delaying
(paying or receiving late).

111
Techniques to optimize cash flow:
Leading and lagging strategy:
Hard currency receivable is lagged and
payment is leaded and soft currency receivable
is leaded and payment is lagged.
Hard currency is the currency which is
expected to appreciate in future and Soft
currency is expected to depreciate in future.

112
Techniques to optimize cash flow:
Netting: It refers to offsetting exposure in
one currency with exposure in the same or
another currency whose exchange rates are
expected to move in a way such that loss or
gain on first exposed position will be offset
by gain or loss in the second exposed
position.

113
The advantages of Netting:
Reduces the number of cross border
transaction between parent and subsidiary
company
There is a collective effort among all
subsidiaries to accelerate report and settle
various accounts
It Reduces lead for foreign exchange
conversations
It reduces the limit of hedging
114
Types of Netting:
Bilateral Netting:
It is netting done between parent and
subsidiary or between 2 subsidiaries
Multilateral Netting:
It involves adjustment of funds of even 3rd
party receipt or payment.

115
Techniques to optimize cash flow:
Minimization of tax using international
transfer pricing: If the intra company
transfer is made, and if the transfer price is
higher, then it leads to high profits and hence
more tax has to be paid.
This decision is more complicated in an
MNC because of exchange restrictions,
difference in tax rates between the two
countries, inflation differentials and import
duties and blockage of funds in host country.
116
Investment of surplus cash:
Money market instruments.
Capital market instruments.
Real estate.
Gold.
Insurance.
Government securities.
Provident fund.
Bank deposit.
Mutual fund.
Derivative and commodity instruments.
117
International Receivable Management:
The level of International receivables depends upon:
The volume of credit sales.
The average collection period.
Credit standards.
Credit terms.
Collection Policy.

118
Strict credit policy Vs Liberal Credit Policy.
Strict Credit policy results in lower Sales, but
with fewer bad debts and fewer collection
expenses resulting in fewer profits.
Liberal credit policy will results in higher
sales and better profits but it comes with
higher bad debt cost and collection expenses.

119
Risk:
Risk can be defined as the quantifiable
likelihood of loss or less than expected return.
Risk can be defined as the probability of
unfavorable condition.
Risks are future issues which can be avoided
or mitigated through the process of hedging.
Risk is the product of severity of a hazard
resulting in an adverse event times the
severity of the event.
120
Risk Management:
Risk Management is a process of
identification, analysis and mitigation of risk
in Investment decision making.
It is a simple two step process of
Determination of Risk that exits in an
Investment and handling the same in the
best suited manner so as to achieve the
planned investment objective.

121
Financial Risk:
Financial Risk refers to risk associated with
any form of financing whether equity,
preference or debt.
It is the risk associated with the mix of
capital structure.
Specifically it refers to risk associated with
Debt financing where it includes the risk of
non payment of interest or the repayment of
principal amount in time.
122
Risk Vs Uncertainity:
Risk is a situation where the investor can
assign probabilities to the possible outcome
whereas Uncertainity is immeasurable.
Risk is present when future event occurs
with measurable probability whereas
Uncertainity is present where the likelihood
of future event is indefinite or immeasurable.
Risk is the possibility of loss whereas
Uncertainity is a future event which is
indefinite or indeterminate. 123
 Types of Risk:
Political Risk:
Political risk refers to risk host countries Political
decision either at Macro or Micro level which will
affect the profits of the multinational firm
adversely.
Ex: Acts of war, terrorism, Laws pertaining to
movement of capital, higher taxes to MNC’s etc.
Political risk can be reduced by local financing,
purchasing the rawmaterial and components
locally, and by less dependence on parent
company.
124
Types of Risk:
Commercial Risk:
Commercial risk refers to risk of expected
cash flows differing from actual cash flows.
It includes all those risks other than
Political risks. Commercial risk arises
irrespective of the political conditions in
that particular host country.

125
 Types of Risk:
Commercial Risk:
Ex: It can arise due to change in Demand,
Supply, Selling price, Costs, Banker not
committing to his responsibilities, Buyers
financial limitations, Sellers limitation in
meeting the right quantity and quality of
goods etc.

126
 Types of Risk:
Economic Risk:
 It is the risk of Cash inflows realised from
sale of a product or a service not covering
its cost i.e. cash outflows.
Economic risk refers to the risk of Cash
Inflows being less than the estimate and
Cash Outflows being more than what was
estimated, resulting in actual net cash
profits being less than the estimate.
127
Remittance Risk:
Exchange control restrictions refers to
restrictions imposed by the Government of the
Host country on all Foreign currency receipts and
payments.
Exchange control restrictions affects the free flow
of receipts and payments of foreign currency from
one country to another.
Exchange control restrictions on remittances
made by subsidiary to parent company in the
form of dividends shall be looked through by
MNC’s. 128
Exchange Control restrictions on remittances:
Exchange control restrictions can be in the
form of charging with holding tax, fixing ceiling
limits on maximum dividends that can be paid
by the subsidiary company, Lock in time period
on Investments made by subsidiary etc.
These restrictions ensure no free flow of funds
from host country to home country and it also
encourages reinvestment of profits in the host
country itself rather than transfering the same
to home country.
129
Differing Tax Systems:
The multiple tax jurisdictions and varying
tax rates among different countries makes
International taxation as one of the most
important risks to be considered by MNC’s.
International Tax systems should be neutral,
equitable and must avoid double taxation
effect.
It should be neutral enough to allow flow of
funds to move from low return country to
high return countries. 130
Differing Tax Systems:
It should be equitable in terms of
progressive system of taxation.
It should avoid double taxation by providing
necessary tax credits, bilateral and
multilateral agreements.
Thus the International taxation system of an
MNC’s should consider differing tax systems
prevailing in home and host countries so as
to take the overall benefit of reduced
taxation. 131
Modes of Double taxation relief:
Credit system without deferral.
Credit system with deferral.
Tax Exemptions.
Admissibility of tax paid as expenditure.
Investment Credit.

132
FOREIGN EXCHANGE EXPOSURE AND
EXCHANGE RATE FLUCTUATIONS:
Foreign exchange exposure is defined as the
sensitivity of value of assets, liabilities or
operating incomes of a MNC due to
unexpected changes in exchange rates.
It is the level of commitment and the degree
to which a MNC is affected because of
unexpected exchange rate movements.

133
FOREIGN EXCHANGE RISK:
Foreign exchange risk emanates due to the
presence of Foreign Exchange Exposure and
it is the variability of domestic currency value
of an asset, liability or an operating income
due to unexpected changes in exchange rates.
Higher the exposure, higher is the foreign
exchange risk and vice versa. No exposure to
a particular currency, will have no foreign
exchange risk to that particular currency.
134
TYPES OF FOREIGN EXCHANGE EXPOSURE:
TRANSLATION EXPOSURE.
TRANSACTION EXPOSURE.
ECONOMIC EXPOSURE.

135
TRANSLATION EXPOSURE:
It is the exposure arising out of need to convert
values of various foreign currency denominated
assets, liabilities, and Operating incomes into
local or domestic currency denominated assets,
liabilities and Operating incomes for
consolidation of financial statements and
reporting purpose.
Translation Exposure is also called as Accounting
Exposure since it is notional in nature as there is
no real exchange rate gain or loss since the asset
or liability is not sold to realise the gain or loss.
136
TRANSLATION EXPOSURE:
Translation exposure arises only when the rate at
which initial transaction is recorded is different
from the rate at which it is translated on the date
of consolidating the financial statement.
Ex: If at the time of occurring of transaction if
Historical rate (Rate at the time of occurring of
transaction) is considered and on the date of
consolidation, if Current rate (Rate at the time of
Consolidating of transaction) is considered, then
it results in Translation exposure.
137
TRANSLATION EXPOSURE:
Translation exposure does not arise in case of
those assets and liabilities which are initially
recorded and translated at the same rate.
The assets and liabilities which are to be
translated at current rate are considered to be
exposed and those assets and liabilities
which are translated at historical rate are not
considered to be exposed. Hence, translation
exposure refers to the difference between
exposed assets and exposed liabilities.
138
TRANSLATION EXPOSURE:
Measurement of translation exposure is
retrospective in nature and it arises on
account of past transactions translated at a
rate different from there historical rate.
Ex: If Stock is recorded at Historical rate and
on the date of consolidation, it is recorded at
Current rate, then it results in translation
exposure.

139
TRANSACTION EXPOSURE:
Transaction Exposure arises due to changes
in the value of outstanding foreign currency
denominated contracts.
It arises on account of foreign currency
denominated transactions committed by the
firm to complete in future.
The measurement of transaction exposure is
both retrospective and prospective in nature
because it is based on activities that occur in
the past but will be settled in the future. 140
TRANSACTION EXPOSURE:
Ex: If a firm as made a Credit purchase of
Goods from a Foreign exporter for $1,00,000
payable after 3months, and due to exchange
rate movements its payability after 3months
differs, then the firm is said to be exposed to
transaction exposure.

141
ECONOMIC EXPOSURE:
It is the extent to which the Present value of
Expected future cash flows of the firm are
exposed to exchange rate movements.
Economic Exposure is also called as
Operating exposure and are results of future
transactions which have no accounting
consequences.
They are real in nature and are not notional
unlike Translation or Accounting Exposure.
142
ECONOMIC EXPOSURE:
Economic Exposure describes the risk of
future cash flows changing due to exchange
rate movements. It mentions that expected
change in the value of the firm based on
exchange rate movements.
These are exposure arising out of
transactions which do not have fixed
contractual commitments.

143
ECONOMIC EXPOSURE:
It measures the extent to which currency
exposure can alter a company’s future operating
cash flows. The measurement of operating
exposure is prospective in nature and it is based
on future activities of the firm. It effects
revenues and costs associated with future sales.
Ex: Exposure faced by a Firm in terms of future
sales to a country due to exchange rate
fluctuations.

144
METHODS OF TRANSLATION EXPOSURE:
1. Current and Non current method:
Under this method, all current assets and current
liabilities of foreign affiliate are translated into home
currency at the current exchange rate while the non
current assets and non current liabilities are
translated at historical rates that is, the rate in effect
when the asset was acquired or liability was incurred.
The income statement is translated at the average
exchange rate of the period, except for those revenues
and expense items associated with non current assets
or liabilities.
145
METHODS OF TRANSLATION EXPOSURE:
2. Monetary and Non monetary method:
According to this method all monetary assets and
monetary liabilities are translated at current rates
where as non monetary assets and liabilities are
translated at historical rates.
Monetary items are those items which represent a
claim to receive or an obligation to pay a fixed
amount of foreign currency units. Eg: Cash, account
receivables (Debtors + Bills receivable), Accounts
payables ( creditors + Bills payable), other current
liabilities, long term debt etc.
146
METHODS OF TRANSLATION EXPOSURE:
Non Monetary items are those items that
do not represent a claim to receive or an
obligation to pay a fixed amount of foreign
currency units. Eg: Stock, fixed assets, equity
shares, preference shares etc. 
The income statement is translated at the
average exchange rate of the period, except
for those revenues and expense items
associated with non monetary assets or
liabilities.
147
METHODS OF TRANSLATION EXPOSURE:
3. Temporal Method:
It is a modified version of monetary and non
monetary method. The only difference between
monetary and non monetary method and
temporal method is “valuation of stock”.
Under monetary/non monetary method, stock is
considered as non monetary assets and it is
valued at historical rate; where as under temporal
method, stock is valued at historical rate, if it is
shown at cost price or it is valued at current rate if
it is shown at market price.
148
METHODS OF TRANSLATION EXPOSURE:
4. Current Rate Method:
Under this method, all balance sheet items
are translated at current exchange rate,
except for share holder’s equity (share capital
+ reserves and surplus) which is translated at
historical rate.

149
Exchange Rate under Accounting Exposure Method:
HR: Historical Rate and CR: Current Rate
Items Current/ Non- Monetary/Non- Temporal Method Current Rate
current Method monetary Method Method

Cash CR CR CR CR

Receivables CR CR CR CR

Inventory CR HR HR /CR CR

Fixed Assets HR HR HR CR

Payables CR CR CR CR

Long term Debt HR CR CR CR

Net worth HR HR HR HR

150
THE BALANCE OF PAYMENT:
MEANING:
Balance of payment of a Country is a systematic
accounting record of all economic transactions during
a given period of time between the residents of the
country and residents of foreign countries. It
represents an accounting of country’s international
transactions for a particular period of time, generally a
year. It accounts for transactions by individual,
businesses and Government.

151
ECONOMIC TRANSACTIONS:
It refers to transfer of economic value from one economic agent
to another. Transfer can be Bilateral or Unilateral. The following
are the different types of economic transactions:
One Real and another Financial Transfer.
Ex: Purchase or Sale of goods and services.
Two Real Transfers.
Ex: Barter transactions.
Two Financial Transfers.
Ex: Purchase of foreign securities for payment in cash.
One Real Transfer.
Ex: A Unilateral gift in kind.
One Financial Transfer.
Ex: A Unilateral Financial gift.
152
BALANCE OF PAYMENT ACCOUNTING:
BOP conforms to the principles of double
entry system i.e. every international
transaction should have a debit and
corresponding credit. BOP is neither an
income statement nor a Balance sheet. It is a
statement of Sources and Application of
funds that reflects changes in assets,
liabilities and Networth during a specified
period of time.

153
BALANCE OF PAYMENT ACCOUNTING:
Decrease in assets, increase in liabilities and increase in
Networth represent credit or Sources of fund and similarly
Increase in assets, decrease in liabilities and decrease in
Networth represent debit or Application of funds. Sources of
funds (Credits) include export of goods and services,
investment and interest earnings, unilateral transfers received
from abroad and loans from foreigners. Application of funds
(Debits) include import of goods and services, dividends paid
to foreign investors, transfer payments abroad, loans to
foreigners and increase in reserve assets. In short transactions
which earn foreign exchange inflows are credits and those
which expend or use up foreign exchange are debits.

154
BALANCE OF PAYMENT ACCOUNTING:

If expenditure abroad by residents of one nation

exceeds what the residents of that nation can earn
from abroad, that nation is supposed to have a
“Deficit” in BOP. However if a nation receives from
abroad more than what it spends, then it is supposed
to have “Surplus”.

155
COMPONENTS OF BALANCE OF
PAYMENT:
1. The Current Account:
It is typically divided into 3 categories namely, merchandise
trade balances, services balance and the balance on
unilateral transfers. Entries are recorded at their current
value and surplus in current account represents an inflow
of funds while a deficit represents an outflow of funds.
The balance of merchandise trade refers to balance
between exports and imports of goods such as machinery,
automobiles etc. Services also called Invisibles include
interest payments, shipping and insurance fees, tourism,
dividends, military expenses etc. Unilateral transfers
include gifts and grants from both private and
Government.

156
COMPONENTS OF BALANCE OF
PAYMENT:
2. The Capital Account:
Capital account consists of Foreign investment
including direct Investment and portfolio
Investments, Loans, Banking Capital, Rupee debt
service and other Capital. It includes acquisition of
firms, Purchase and sale of stocks, Establishment of
subsidiaries, etc.

157
COMPONENTS OF BALANCE OF
PAYMENT:
3. The Official Reserve Account:
These are Government owned assets which represents
purchases and sales by the central bank of the country.
The changes in the Official reserve account are
necessary to account for the deficit or surplus in the
BOP.

158
FORMAT
I. Current Account:
 a) Merchandise
 b) Services (Invisibles)
 c) Other Income (Transfers and others)
II. Capital Account:
 a) Foreign Investment.
 b) Loans.
 c) Banking Capital.
 d) Rupee Debt service.
 e) Other Capital.
III. Official Reserve Account:
 a) Errors and Omissions.
 b) Overall balance. (Total of Current Account, Capital Account and Errors and
Omissions)
 c) Monetary Movements.

159
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160