Uploaded by Dr. Chandan Singh

International Financial Management

International Financial
Section I
3.2 Working capital management
1)The essence of international financial
3.3 Trade Finance
3.4 Letter of credit
1.1 Concept and main functions of IFM
3.5 Bank Guarantee
3.6 Collection and discounting of bills
3.7 Dividend Police
3.8 Risk management
1.2 Nature & Scope
1.3 International Trade Theories
2) International Business Methods
Section II
3)General directions of International
Financial Management
The essence of international
financial management
IFM- is a popular concept which means
management of finance in an international business
environment, it implies, doing of trade and making money
through the exchange of foreign currency.
The international financial activities help the
organizations to connect with international dealings with
partnerscustomers, suppliers, lenders. It is also used by
government organization and non-profit institutions.
The essence of international
financial management
S The main objective of international financial management
is to maximise shareholder wealth.
S Adam Smith wrote in his famous title, “Wealth of
Nations” that if a foreign country can supply us with a
commodity Cheaper than we ourselves can make
it, better buy it of them with some part of the produce of
our own in which we have some advantage.
Basic Functions
S This function involves generating funds from
internal as well as external sources.
S The effort is to get funds at the lowest cost
Basic Functions
S It is concerned with deployment of the acquired
funds in a manner so as to maximize shareholder
S Other decisions relate to dividend payment,
working capital and capital structure etc.
S In addition, risk management involves both
financing and investment decision.
Nature & Scope
The treasurer is responsible
for :
financial planning analysis
fund acquisition
investment financing
cash management
investment decision and
risk management
functions related to :
external reporting
financial and management
control, and
accounts receivables etc.
Environment at
International Level
International financial management practitioners are required the
knowledge in the following fields:
the knowledge of latest changes S investment behavior of investors
in forex rates
S export and import trends
instability in capital market
S Competition
interest rate fluctuations
S banking sector performance
macro level charges
S inflationary trends
micro level economic indicators
S demand and supply conditions
savings rate
consumption pattern
Foreign exchange risk
S In a domestic economy this risk is generally ignored because a
single national currency serves as the main medium of
exchange within a country.
S When different national currencies are exchanged for each
other, there is a definite risk of volatility in foreign exchange
S 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.
S In fact, this variability of exchange rates is widely regarded as
the most serious international financial problem facing
corporate managers and policy makers
Political risk
S 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.
S 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
Expanded Opportunity Sets
S When firms go global, they also tend to benefit from
expanded opportunities which are available now.
S They can raise funds in capital markets where cost of
capital is the lowest.
S The firms can also gain from greater economies of scale
when they operate on a global basis
International Trade Theories
Theory of Mercantilism
This theory is during the sixteenth to the three-fourths
of the eighteenth centuries.
It beliefs in nationalism and the welfare of the nation
alone, planning and regulation of economic activities
for achieving the national goals, restriction imports
and promoting exports.
It believed that the power of a nation lied in its
wealth, which grew by acquiring gold from abroad.
Theory of Mercantilism
• Mercantilists failed to realize that simultaneous export
promotion and import regulation are not possible in all
countries, and the mere control of gold does not enhance
the welfare of a people.
• Keeping the resources in the form of gold reduces the
production of goods and services and, thereby, lowers
S It was rejected by Adam Smith and Ricardo by stressing
the importance of individuals, and pointing out that their
welfare was the welfare of the nation.
Theory of Absolute Cost
This theory was propounded by Adam Smith (1776), arguing
that the countries gain from trading, if they specialise
according to their production advantages.
S The pre-trade exchange ratio in Country I would be 2A=1B and
in Country II IA=2B.
Theory of Absolute Cost
If it is nearer to Country I domestic exchange ratio then trade
would be more beneficial to Country II and vice versa.
Assuming the international exchange ratio is established
The terms of trade between the trading partners would depend
upon their economic strength and the bargaining power.
Theory of Comparative
Cost Advantage
Ricardo (1817), though adhering to the absolute
cost advantage principle of Adam Smith, pointed
out that cost advantage to both the trade partners
was not a necessary condition for trade to occur.
S According to Ricardo, so long as the other
country is not equally less productive in all
lines of production, measurable in terms of
opportunity cost of each commodity in the
two countries, it will still be mutually gainful
for them if they enter into trade.
Theory of Comparative
Cost Advantage
S In the example given, the opportunity cost of one unit of A in
country I is 0.89 (80/90) unit of good B and in country II it is
1.2 (120/100) unit of good B.
S On the other hand, the opportunity cost of one unit of good
B in country I is 1.125 (90/80)units of good A and 0.83
(100/120) unit of good A, in country II.
Theory of Comparative
Cost Advantage
The opportunity cost of the two goods are different in
both the countries and as long as this is the case, they
will have comparative advantage in the production of
either, good A or good B, and will gain from trade
regardless of the fact that one of the trade partners may
be possessing absolute cost advantage in both lines of
S Thus, country I has comparative advantage in good A as
the opportunity cost of its production is lower in this
country as compared to its opportunity cost in country II
which has comparative advantage in the production of
International Business
S Licensing
S Franchising
S Subsidiaries and Acquisitions
S Strategic Alliances
S Exporting
S License -means to give permission. A license may be
granted by a party ("licensor") to another party
("licensee") as an element of an agreement between
those parties.
S A license may be issued by authorities, to allow an
activity that would otherwise be forbidden. It may require
paying a fee and/or proving a capability. The requirement
may also serve to keep the authorities informed on a type
of activity, and to give them the opportunity to set
conditions and limitations.
S Franchising is the practice of selling the right to use a
firm's successful business model. For the franchisor, the
franchise is an alternative to building 'chain stores' to
distribute goods that avoids the investments and liability
of a chain. The franchisor's success depends on the
success of the franchisees. The franchisee is said to
have a greater incentive than a direct employee because
he or she has a direct stake in the business.
S The franchisor is a supplier who allows an operator, or a
franchisee, to use the supplier's trademark and distribute
the supplier's goods. In return, the operator pays the
supplier a fee.
Subsidiaries and Acquisitions
S A subsidiary is a company that is completely or partly owned
by another corporation that owns more than half of the
subsidiary's stock, and which normally acts as a holding
corporation which at least partly or a parent corporation, wholly
controls the activities and policies of the daughter corporation.
S Mergers and acquisitions are both aspects of corporate
strategy, corporate finance and management dealing with the
buying, selling, dividing and combining of different companies
and similar entities that can help an enterprise grow rapidly in
its sector or location of origin, or a new field or new
location, without creating a subsidiary, other child entity or
using a joint venture.
Strategic Alliances
S A strategic alliance is an agreement between two or more
parties to pursue a set of agreed upon objectives needed while
remaining independent organizations. This form of cooperation
lies between Mergers & Acquisition M&A and organic growth.
S Partners may provide the strategic alliance with resources such
as products, distribution channels, manufacturing capability,
project funding, capital equipment, knowledge, expertise, or
intellectual property. The alliance is a cooperation or
collaboration which aims for a synergy where each partner
hopes that the benefits from the alliance will be greater than
those from individual efforts.
Section II
Capital Budgeting
S It is the planning process used to determine whether an
organization's long term investments such as new
machinery, replacement machinery, new plants, new
products, and research development projects are worth
the funding of cash through the firm's capitalization
S It is the process of allocating resources for major capital,
or investment, expenditures.
S One
of the primary goals of capital budgeting
investments is to increase the value of the firm to the
Methods of capital Budgeting
S Accounting rate of return
S Payback period
S Net present value
S Profitability index
S Internal rate of return
S Modified internal rate of
S Equivalent annuity
S Real options valuation
These methods use the incremental
cash flows from each potential
investment, or project
Factors influencing Capital
S Availability of
S Structure of
S Lending Policies
of Financial
S Economic Value
of the Project
S Taxation Policy
S Government
S Immediate need
of the Project
S Earnings
S Working Capital
S Accounting
S Capital Return
S Trend of Earning
Foreign Portfolio Investment
S Foreign portfolio investment is the entry of funds into a
country where foreigners make purchases in the country’s
stock and bond markets, sometimes for speculation.
S It is a usually short term investment, as opposed to the longer
term Foreign Direct Investment partnership, involving transfer
of technology and "know-how".
S Foreign Portfolio Investment (FPI): passive holdings of
securities and other financial assets, which do NOT entail
active management or control of the securities' issuer. FPI is
positively influenced by high rates of return and reduction of
risk through geographic diversification. The return on FPI is
normally in the form of interest payments or non-voting
Working Capital Management
S Working capital management is concerned with the problems that
arise in attempting to manage the current assets, the current
liabilities and the interrelations that exist between them.
S Current assets refer to those assets which in the ordinary course
of business can be, or will be, converted into cash within one year
without undergoing a diminution in value and without disrupting
the operations of the firm.
Examples- cash, marketable securities, accounts receivable and
S Current liabilities are those liabilities which are intended, at their
inception, to be paid in the ordinary course of business, within a
year, out of the current assets or the earnings of the concern.
Examples- accounts payable, bills payable, bank overdraft and
outstanding expenses
Goal of Working Capital
S To manage the firm’s current assets and
liabilities in such a way that a satisfactory
level of working capital is maintained.
Concepts and Definitions of
Working Capital
There are two concepts of working capital:
Gross and Net
S Gross working capital- means the total current assets.
S Net working capital- can be defined in two wayso The difference between current assets and current
o The portion of current assets which is financed with long
term funds
Determinants of Working
capital Requirement
S General nature of business S Level of taxes
S Production cycle
S Dividend policy
S Business cycle fluctuations S Depreciation policy
S Production policy
S Price level changes
S Credit policy
S Operating efficiency
S Growth and expansion
S Profit level
Working capital: Policy and
S The working capital management includes and refers to the
procedures and policies required to manage the working
There are three types of working capital policies which a firm
may adopt :
S Moderate working capital policy
S Conservative working capital policy
S Aggressive working capital policy.
These policies describe the relationship between the sales level
and the level of current assets.
Types of working capital
S The working capital need can be bifurcated into permanent
working capital and temporary working capital.
S Permanent working capital- There is always a minimum
level of working capital which is continuously required by a firm in
order to maintain its activities like cash, stock and other current
assets in order to meet its business requirements irrespective of
the level of operations.
S Temporary working capital- Over and above the permanent
working capital, the firm may also require additional working
capital in order to meet the requirements arising out of fluctuations
in sales volume. This extra working capital needed to support the
increased volume of sales is known as temporary or fluctuating
working capital.
Trade Finance
S For a trade transaction there should be a Seller to sell the
goods or services and a Buyer who will buy the goods or
use the services. Various intermediaries such as (banks
, Financial Institutions) can facilitate this trade transaction
by financing the trade.
S While a seller (the exporter) can require the purchaser
(an importer) to prepay for goods shipped, the purchaser
(importer) may wish to reduce risk by requiring the seller
to document the goods that have been shipped. Banks
may assist by providing various forms of support.
The following are the most famous
products/services offered by various Banks and
Financial Institutions in Trade Finance Segment:
Letter of Credit
S It is an undertaking promise given by a Bank/Financial
Institute on behalf of the Buyer/Importer to the
Seller/Exporter, that, if the Seller/Exporter presents the
complying documents to the Buyer's designated
Buyer/Importer in the Purchase Agreement then the
Buyer's Bank/Financial Institute will make payment to the
Bank Guarantee
S It is an undertaking promise given by a Bank on behalf of
the Applicant and in favour of the Beneficiary.
Whereas, the Bank has agreed and undertakes that, if
the Applicant failed to fulfill his obligations either Financial
or Performance as per the Agreement made between the
Applicant and the Beneficiary, then the Guarantor Bank
on behalf of the Applicant will make payment of the
guarantee amount to the Beneficiary upon receipt of a
demand or claim from the Beneficiary.
Collection and Discounting
of Bills
S It is a major trade service offered by the Banks. The
Seller's Bank collects the payment proceeds on behalf of
the Seller, from the Buyer or Buyer's Bank, for the goods
sold by the Seller to the Buyer as per the agreement
made between the Seller and the Buyer.
Dividend Policy
S Dividend policy is concerned with financial policies regarding
paying cash dividend in the present or paying an increased
dividend at a later stage. Whether to issue dividends, and what
amount, is determined mainly on the basis of the company's
unappropriated profit and influenced by the company's longterm earning power. When cash surplus exists and is not
needed by the firm, then management is expected to pay out
some or all of those surplus earnings in the form of cash
dividends or to repurchase the company's stock through a
share buyback program.
Risk Management
S Risk management is the identification, assessment, and
prioritization of risks followed by coordinated and
economical application of resources to minimize, monitor,
and control the probability and/or impact of unfortunate
events or to maximize the realization of opportunities.
S Risks can come from uncertainty in financial markets,
threats from project failures (at any phase in design,
development, production, or sustainment life-cycles),
legal liabilities, credit risk, accidents, natural causes and
disasters as well as deliberate attack from an adversary,
or events of uncertain or unpredictable root-cause.
Methods of risk management
S Identify, characterize threats
S Assess the vulnerability of critical assets to specific
S Determine the risk (the expected likelihood and
consequences of specific types of attacks on specific
S Identify ways to reduce those risks
S Prioritize risk reduction measures based on a strategy
Principles of risk
S Risk management should:
S create value – resources expended
to mitigate risk should be less than
the consequence of inaction, or (as
in value engineering), the gain
should exceed the pain
S be an integral part of organizational
S be part of decision making process
S explicitly address uncertainty and
S be systematic and structured process
S be based on the best available
S be tailorable
S take human factors into account
S be transparent and inclusive
S be dynamic, iterative and responsive
to change
S be capable of continual improvement
and enhancement
S be continually or periodically re-
S Compared to national financial markets international markets have a
different shape and analytics. Proper management of international finances
can help the organization in achieving same efficiency and effectiveness in
all markets, hence without IFM sustaining in the market can be difficult.
S Companies are motivated to invest capital in abroad for the following
S -Efficiently produce products in foreign markets than that domestically.
S -Obtain the essential raw materials needed for production
S -Broaden markets and diversify
S -Earn higher returns
Thank You for Attention!