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  1. 1. International Financial Management(IFM) REVISION QUESTIONS Section – A (Two Marks Questions) 1. What are „invisibles‟ in the balance of payments A. The current account records all exports and imports of merchandise and invisibles. Invisibles include (a) Services b) income flows iii) unilateral transfers Services earnings/payments include earnings on royalties, transportation and communication. Income flows includes payments made or payments received on foreign borrowings, earnings in the form of interest, dividends and rent. Unilateral transfers like contributions to international institutions, gifts or aid to the foreigners. 2. What is the law of one price A. The law of one price states that “ if a commodity or product can be sold in two different markets, its price should be the same in both the markets”. 3. What is foreign exchange risk? A. The risk that the one currency will appreciate or depreciate against another currency over a period of time. 4. What is forward rate? A. Forward rate is the rate negotiated agreement between two parties for selling/buying specified amount of a specified currency at a fixed rate and date. If the exchange of currencies takes place after a certain period from the date of the deal (more than two working days) it is called forward rate. 5. What is a currency futures contract? A. A currency futures contract is a standardized agreement to deliver or receive a specified amount of a specified currency at a fixed rate and date 6. What is „functional currency‟ and reporting currency? A. Functional currency is defined as the currency in which the affiliate operates and in which it generates cash flows. Generally it is the local currency of the country in which the affiliate conducts most of its business. Under certain circumstances the functional currency may be the parent‟s firm‟s home currency or some third country currency. The reporting currency is the currency in which the parent firm prepares its own financial statements. This currency is normally the home currency, i.e the currency of the country currency i.e the currency of the country in which the parent is located and conducts most of its business
  2. 2. 8. What is covered interest rate arbitrage? A . The covered Interest arbitrage is the act of making profits by exploiting the lack of equality between forward premium /discount on a foreign currency and the interest in the two currencies. Th movement of money to take advantage of a covered interest differential is known as covered interest rate arbitrage. 9. What is marking to market? A. Settling changes in the value of futures contracts on a daily basis. When the futures are marked to market at the end of each trading day, the previous trading day‟s futures contract is settled. The counterparties realize their profits or losses on a day-to-day basis rather than all at once upon the maturity of the contract. The daily settlement as per the marked-to-market procedure reduces the default risk of the futures contract. 10. What is PPP? A. PPP states that the home currency price of a commodity in different countries when converted into a common currency at the spot exchange rate, is the same in all the countries across the world. 11. Distinguish between Direct and Indirect quotation. A. Direct Quote: A direct quote is the number of units of home currency that can be exchanged for one unit of a foreign currency. 1 FX (foreign currency) = no of units of DX (domestic currency) Indirect Quote: is the number of units of the foreign currency exchanged for one unit of home currency. 1 DX (Domestic currency) = no of units of FX(foreign currency) 12. What is clean and direct float? A. Dirty Float: It is an exchange rate system in which exchange rates are allowed to fluctuate without set boundaries and government intervene as they wish Clean Float: It is an exchange rate system in which exchange rates are allowed to fluctuate as per the demand and supply and government/monetary authority do not intervene. 13. Who are the participants in the foreign exchange market? A. The participants of the foreign exchange market are i. Retail Customers: Tourists, Students seeking education, restaurants, shops hotels, importers and exporters. ii. Foreign Exchange dealers (Wholesalers) which include large commercial banks investments banks, corporations, HNI(High Net-worth Individuals) iii. Foreign exchange brokers who buy/sell currencies for commission iv. Nation‟s Central Banks like RBI
  3. 3. 14. Define translation exposure? A. Translation exposure is also called as Accounting exposure. It is exposure which measures the effect or impact of the exchange rate changes/fluctuations on the financial statements. It effects both the income statement and balance sheet items 15. What is syndicated loan? A. Syndicated loans are different from general loans in that one of the lending banks is the lead manager who originates the transaction, structures it, selects the lending members, supervises the documentation and in many cases services the loan after agreement is complete. It serves as a link between the borrower and the other banks of the syndicate. It collects interest and principal from the borrower and disburses the collected amount among the co-lenders at an additional fee. 16. Distinguish between absolute and relative PPP theory? A. Absolute PPP: The absolute version of the PPP theory is also called the law of one price, suggests that prices of identical products in two different countries should be equal when measured in common currency. The assumption of the absolute PPP is that there are no transaction costs or trade barriers. The relative form of PPP is an alternative version that accounts for the possibility of market imperfection such as transportation costs, tariffs and quota. According to this version prices of similar products of different countries will not necessarily be the same when measured in a common currency because of these market imperfections. The percentage change in the foreign currency (ef) ef = (1 + Ih ) / (1+ If) – 1 Ih – Inflation rate of the home currency If – Inflation rate of the foreign currency 17. Write the structure of current Account in BOP? A. The current account consists of all exports and imports of merchandise and invisibles. Merchandise includes agricultural commodities and industrial components and products. Invisibles include services, income flows in and out of the country and unilateral gifts. Export of services include various banking, insurance, consulting and accounting undertaken by individuals and firms. Import of services include residents tourists spending abroad, payments made to the firms for their services and royalties on foreign books etc. 18. Who are authorised dealers? A. Authorised dealers are wholesale dealers of the currencies of different countries. These are authorised by the central banks of that particular country to deal with currencies. They normally deal with large amounts of currencies.
  4. 4. 19. State three benefits of centralised cash management system? A. i. Maintaining minimum cash balance during the year. ii. Judiciously manage the liquidity requirements of the centre iii. Optimally utilize the various hedging strategies so as to minimize the MNC‟s foreign exchange exposure iv. Helping the centre to take complete advantage of multinational netting so as to minimize the MNC‟s foreign transaction costs and currency exposure. v. Achieve maximum utilization of the transfer pricing mechanism so as to enhance the profitability and growth by the firm 20. Explain the terms bid rate and offer rate A. Bid rate: Is the rate at which the bank (dealer) buys one unit of the foreign currency Ask rate: Is the rate at which the bank (dealer) sells one unit of the foreign currency 21. What do you mean by short position? A. A market commitment is the number of contracts bought or sold for which no offsetting transaction has been entered into. The buyer of an asset (currency) is said to have a long position, and the seller of an asset (currency) is said to have a short position. One has a long position when one owns something, while one has a short position when something is sold, especially sold short 22. What is country risk? A. Is the risk which emanates from political, social, and economic (financial) instability of a country and manifests in the form of more or less strong hostility towards foreign investments 23. What is economic exposure? A. Economic exposure measures the impact of unanticipated currency changes on monetary transactions as well as the uncertain future cash-flows generated by the firm‟s income-generating real assets. 24. Contrast the speculative and hedging motives for usage of derivatives A. Speculators are the class of investors who willingly take price risks to profit from price changes in the underlying. They want to make quick fortune by anticipating/forecasting future market movements. Hedgers wish to eliminate or reduce the price risk to which they are already exposed. Hedging is a mechanism to reduce price risk inherent in open positions. A hedging can help lock in existing profits.
  5. 5. 27. What do you mean by balance of payments? A. The BOP(Balance of Payments) of a country can be defined as a systematic record of all economic transactions between the residents of a country and the residents of the other countries of the world over a specified period of time(usually one year). It accounts for transactions by individuals, businesses and government. 29. Differentiate between risk and exposure? A. Foreign Exchange Risk is the uncertainty or variance of the domestic currency value of assets, liabilities, unanticipated changes in the foreign exchange rates while Foreign exchange exposure is the measure of the sensitivity of the changes in the real domestic currency value of assets, liabilities or operating incomes. Exposure is a measure of sensitivity of value of the financial items to change in variables like exchange rates, Inflation rates, relative prices etc. 30. What do you mean by soft or weak and hard or strong currency? A. Soft or weak Currency: It is the currency which is expected to depreciate rapidly or that it is difficult to convert into other currencies. Hard or Strong Currency: It is currency which is expected to appreciate and can serve as a reliable and stable value. 31. What is interest rate parity? Explain the terms with examples bid and ask quote. A. The interest rate parity theory states that the difference in the interest rates( risk-free) on two currencies should be equal to the difference between the forward exchange rate and the spot exchange rate if there are to be no arbitrage opportunities. 32. What is the difference between a put on British pounds sterling and call on sterling A. A put on British Pounds provides the holder with the right to sell the underlying currency. A call on sterling provides the holder with the right to buy the underlying currency 33. Define the terms hedging and currency risk A. Hedging is an instrument made in order to reduce the risk of adverse price movements in a security, by taking an offsetting position in a related security such as an option or a short sale. 34. What do you mean by political risk? A. Political risk is the exposure to a change in the value of an investment or cash-flows of a foreign firm arising out of unexpected change in the political environment of the host country. Political risks are caused by the unanticipated changes in the tax laws, labour laws and other laws that hurt the profitability and viability of the foreign projects.
  6. 6. 35. What is dollarization A. Dollarization is system of adopting the currency (dollar or not) of another nation in place of a domestic currency. For example panama has been using the U.S 39. What is triangular Arbitrage? A. If three currencies are involved in an arbitrage operation, it is called a three point arbitrage. In a triangular arbitrage one currency is traded for another currency, which is traded for the third currency, which is then traded for the first currency. Triangular arbitrage exists when the currency direct quotes are not in alignment with the cross exchange rates. 40. What is foreign exchange market? A. The foreign exchange market is a market where one currency is traded for another. It allows currencies to be exchanged in order to facilitate international trade or financial transactions. 41. What is International Capital Budgeting? A. It refers to the analysis of cash inflows and outflows associated with prospective long- -term foreign investment projects. It helps in identifying the cash flows put to risk and estimate cash flows to be derived over time 42. What is foreign Direct Investment? A. Foreign Direct Investment is any form of investment and the parent company builds productive capacity in a foreign country and processes foreign ownership of an enterprise. The IMF defines Foreign Investment as FDI when the investor holds 10% or more of the equity of an enterprise. FDI is an important source of capital. 43. What is multilateral Netting? What is Bilateral Netting A. It refers to offsetting exposure in one currency with exposure in the same or another currency whose exchange rates are expected to move in such a way that loss or gain on first exposed position will be offset by gain or loss in the second exposed position. Bilateral netting is done between two parties and two currencies. 44. What is CTA? A. The gains or losses caused by translation adjustment are not included in the net income but reported separately and accumulated in a separate equity account known as Cumulative Translation Adjustment (CTA). The CTA account helps in balancing the balance sheet.
  7. 7. 45. What are Depository Receipts (DRs) A. It is a type of negotiable (transferable) 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. 46. What is Euro-currency? A. It refers to the currency held by non-residents and placed on deposit with the banks outside the country of the currency. Eg US dollars owned by a ABN AMRO Bank and deposited in London. 47. What is Back-to-Back Loan? A. It is a type of loan where by two companies in different companies borrow offsetting amounts from one another in each others currency. The purpose of this transaction is to hedge against currency risk. Nowadays these are replaced by Currency swaps. 48. What is SWIFT? A. It refers to Society For World Wide Inter Bank Financial Telecommunication. The SWIFT operates a worldwide financial messaging network which exchanges messages between banks and financial institutions. 49. What is the difference between Reciprocal rate and cross rate? A. Reciprocal Rate: It is also known as Indirect quote. It is the number of units of the foreign currency exchanged for one unit of home currency. 1 DX (Domestic currency) = no of units of FX(foreign currency) Cross rate: When quotations are not available for a pair of currency, third currency is used to find out the exchange rate between the pair of the currency. Determining the exchange rate for two unpopular traded currencies by using a third popular currency is called Cross rate. 50. Distinguish between Spot, Forward and Future market. A. The spot market is where securities or currencies are characterised by simultaneous delivery and payment. The payment for the transaction takes place immediately or in T+2 days. Forward Transactions: are transactions in which the price, number and delivery date of the securities to be traded are agreed upon between the buyer and the seller. It is done over the counter (OTC) consisting of tailor made contracts. Future Market: is a market where the price, number and delivery date of the securities to be traded are standardized and are traded over the exchange and the contract agreed upon will be executed at a future date.
  8. 8. 51. What is currency call and put option? A. The right bit not the obligation to buy one currency against another currency is known as Call Option. The right but not the obligation to sell one currency against another currency is known as Put Option 52. Distinguish between Leading and Lagging? A. 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) 53. What do you mean by SDR? A. The SDR (Special Drawing Rights) is an international reserve asset, created by the IMF in 1969 to supplement the existing official reserves of member countries. SDRs are allocated to member countries in proportion to their IMF quota. The SDR also serves as the unit of account of the IMF and some other international organizations. Its value is based on a basket of key international currencies. SDR is a composite reserve asset to supplement existing reserve asset.SDR is valued with a basket of 5 country‟s currencies with the largest share of world exports of goods and services. SDRs can used by countries to reduce the deficits in the balance of payments 54. Define exposure netting. A. Exposure netting involves offsetting exposures in one currency with exposures in the same or another currency, where exchange rates are expected to move in such a way that losses /gains on the first exposed position should be offset by gains/ losses on the second currency exposure. 55. What is money market hedge? A. A money market hedge involves simultaneous borrowing and lending activities in two different currencies to lock the home currency value of a foreign currency cash flow. 56. What do you mean by double Taxation? A. Double taxation means taxation of same income of an individual in more than one country. This results due to countries following different rules for taxation. 57. Explain the meaning of cross-rate consistency? A. The exchange rate for a non-US currency expressed in terms of another US currency is referred to as cross rate. Cross-rate consistency refers to the stability of exchange rate over a period of time.
  9. 9. Section-B --1. Explain the three types of transactions takes place in forex market? A. i. Spot Market: These are the quickest transactions involving currency in foreign markets. These transactions involve immediate payment at the current exchange rate, which is also called the spot rate. The trades usually take place within two days of the agreement. This does leave the traders open to the volatility of the currency market, which can raise or lower the price between the agreement and the trade. ii. Forward Transactions: In this type of transaction, money does not actually change hands until some agreed upon future date. A buyer and seller agree exchange rate for any date in the future date. The date can be days, months or years. Examples include: i) Futures ii) Swap Futures Market: These transactions involve future payment and future delivery at an agreed exchange rate, also called the future rate. These contracts are standardized, which means the elements of the agreement are set and non-negotiable. It also takes the volatility of the currency market, specifically the spot market, out of the equation. These are popular among traders who make large currency transactions and are seeking a steady return on their investments. Forward Market: These transactions are identical to the Futures Market except for one important difference---the terms are negotiable between the two parties. This way, the terms can be negotiated and tailored to the needs of the participants. It allows for more flexibility. In many instances, this type of market involves a currency swap, where two entities swap currency for an agreed-upon amount of time, and then return the currency at the end of the contract. iii. Options: This transaction overcomes the problems of forward transactions, an option provides its owner the right to sell/buy a specified amount of foreign currency at a specified price. 2. State the main features of currency futures? A. The main features of currency futures are • Is a standardized agreement to sell or buy a specified amount of currency at a fixed rate and date • Currency futures trade on a quarterly cycle, being in the month of March, June, September and December. The future maturing on the Monday before the third wednesday of the month • Every trader who desires to buy or sell futures contracts must open an account with his or her broker and deposit some amount before the transaction is executed. The amount thus deposited is known as Initial Margin. The initial margin is a certain percentage of futures contract. • Unlike a forward contract future contract are settled every trading day at the settlement price. This process is called marking to market. At the end of the day a party‟s gain (loss) is added to (subtracted) from the margin account.The balance in the margin account of the investor should never be negative. In order to ensure that another kind of margin, known as the maintenance margin or maintenance performance bond. If the balance goes down below the maintenance margin a margin call is given to the trader to replenish or rather square-off. • Currency futures transactions can be closed out either through delivery of the underlying foreign currency on full settlement or by an offsetting trade.
  10. 10. 3. State the methods of managing transaction exposure OR Bring out the various internal strategies a firm can take if it anticipates depreciation /appreciation of home currency against the foreign currency A. Transaction exposure can be hedged by financial contracts like i) Forward Market Hedge ii) Future Hedge iii) Money Market Hedge iv) Options Market Hedge i) Forward contracts can be used to lock in the futures exchange rate at which an MNC can buy or sell a currency. A forward rate at which a MNC can buy or sell a currency.A forward market are used for large transactions whereas the futures market hedge are used for small contracts. ii) Currency Futures can be used by firms that desire to hedge transaction exposure either by purchasing currency futures or by selling a currency future for a stated price on a specified date. iii) Money market hedge involves simultaneous borrowing & lending activities in two different currencies to lock in the home currency value of a future foreign currency cash flow. The simultaneous borrowing & lending activities enable a company to create a home-made forward contracts. The firm seeking money market hedge borrows in one currency & exchanges the proceeds for another currencies iv) Options market hedge: Forward hedge and Money market hedge can backfire when a payable currency depreciates (or) a receivables currency appreciates over the hedge period. In such situations an un-hedged strategy would likely outperform the forward hedge or money market hedge. The ideal type of hedge would insulate the firm from adverse exchange rate movements but also allow the firm to benefit from favourable exchange rate movements. The other alternative Hedging Techniques for transaction exposure are: a) Leading or lagging b) Currency swaps c) Cross Hedging d) Pricing of transactions e) Currency Diversification f) Matching of cash flows g) Risk Sharing h) Parallel Loans or Back-to-Back loans 4. Why do discrepancies arises in the balance of payment? A. Discrepancies may arise in the balance of payments because there is no single source for balance of payments data and no way to ensure that data from different sources are fully consistent. Sources include customs data, monetary accounts of the banking systems, external debt records, information provided by enterprises, surveys to estimate service transactions and foreign exchange records. Differences in recording methods for example in the timing of transactions in definitions of residence and ownership and in the exchange rate used to value transactions contribute to net errorsand omissions. In addition smuggling and other illegal or quasi-legal transactions may be unrecorded or misrecorded.
  11. 11. 5. What factors influencing pricing of a currency option? A. The factors affecting the Currency Options are i. Exercise price and the share/underlying asset price: If the underlying asset is a currency the value of the call option would increase as the value of the currency increase ii. Volatility of an underlying asset: The greater the risk of the underlying asset, the greater the value of an option. iii. Interest rate: The present value of the exercise price will depend on the interest rate (and the time until expiration of the option) . The value of a call option will increased with the rising interest rate since the present value of the exercise price will fall. The buyer of the put option receives the exercise price and hence, with increasing interest rate the value of put option declines iv. Time and date to option expiration: The present value of the exercise price will be less if the time to expiration is longer and consequently the value of the option will be higher. v. Strike Price vi. Whether it is a call or put 6. Distinguish between currency futures and options? A. Currency Options Currency Futures 1.obligations An currency option gives the buyer A futures contract gives the the right, but not the obligation to buyer the obligation to buy (or sell) a certain currency at a purchase a specific Currency, specific price at any time during the and the seller to sell and deliver life of the contract that asset at a specific future date 2.commission/ Besides commission an investor can an options position does premium enter into a futures contract with no require the payment of a upfront cost premium 3. underlying Comparatively lesser for options is much larger for futures position contracts 4. Gain The gain on a option can be realized gains on futures positions are in the following three automatically marked to ways: exercising the option when it market daily, meaning the is deep in the money, going to the change in the value of the market and taking the opposite positions is attributed to the position, or waiting until expiry and futures accounts of the parties collecting the difference between at the end of every trading day the asset price and the strike price - but a futures contract holder can realize gains also by going to the market and taking the opposite position. 7. Explain the different types of transactions takes place in forex market or Briefly describe the foreign exchange derivatives market? A. The common derivatives products are forwards, futures, options and swaps. Currency Market Hedges To hedge currency exposure is through devices of several currency markets-forward contracts, futures contracts, currency options, and currency swaps. Currency FuturesClosely related to the use of a forward contract is a futures contract. A currency futuresmarket exists for the major currencies of the world. For example, the Australian dollar, theCanadian dollar, the British pound, and the Swiss franc, and the yen. A futures contract is astandardized agreement
  12. 12. that calls for delivery of a currency at some specified future date,either the third Wednesday of March, June, September, or December. Contracts are traded onan exchange, and the clearinghouse of the exchange interposes itself between the buyer andtheseller. This means that all transactions are with the clearinghouse, not made directlybetween two parties. Very few contracts involve actual delivery at expiration. Rather, a buyerand a seller of a contract independently take offsetting positions to close out a contract. Theseller cancels a contract by buying another contract, while the buyer cancels a contract byselling another contract.CurrencyOptionsForward and futures contracts provide a "two-sided" hedge against currency movements.That is, if the currency involved moves in one direction, the forward or futures positionoffsets it. Currency options, in contrast, enable the hedging of "one-sided" risk. Only adversecurrency movements are hedged, either with a call option to buy the foreign currency or witha put option to sell it. The holder has the right, but not the obligation, to buy or sell thecurrency over the life of the contract. If not exercised, of course" the option expires. For thisprotection, one pays a premium.There are both options on spot market currencies and options on currency futurescontracts. Because currency options are traded on a number of exchanges throughout theworld, one is able to trade with relative ease. The use of currency options and their valuationare largely the same as for stock options. The value of the option, and hence the premiumpaid, depends importantly on exchange-rate volatility.CurrencySwapsYet another device for shifting risk is the currency swap. In a currency swap two partiesexchange debt obligations denominated in different currencies. Each party agrees to pay theothers interest obligation. At maturity, principal amounts are exchanged, usually at a rate ofexchange agreed to in advance. The exchange is notional in that only the cash-flow differenceis paid. If one party should default, there is no loss of principal per se. There is, however, theopportunity cost associated with currency movements after the swaps initiation.Currency swaps typically are arranged through an intermediary, such as a commercialbank. Many different arrangements are possible: a swap involving more than two currencies;a swap with option features; and a currency swap combined with an interest-rate swap, wherethe obligation to pay interest on long-term debt is swapped for that to pay interest on short-term, floating-rate, or some other type of debt. As can be imagined, things get complicatedrather quickly. The point to keep in mind, however, is that currency swaps are widely usedand serve as longer-term risk-shifting devices. 8. Distinguish between futures and forwards A. Feature Forward Contracts Future ContractsType of contract Customized Standardized Maturity As desired by contracting There are only few parties usually in maturity dates such as multiples of 30 days quarterly in an year Contract Size Generally large averaging Small enough that it is more than 1 million accessible to small-scale dollars per contract forex participants Security Arrangements Bank forward customers All traders must maintain must maintain minimum margin deposits that are deposit balances small % of the contract values Cash flows No cash flow until Daily settlement results in delivery cash payments to some parties Final settlement 90% of the forward are Less then 2% is physical settled physically by delivery remaining 98% is delivery cash settlement Default risk There is substantial loss Default risks are taken can occur if one party care by the margins paid defaults to the exchange Variety of currencies Forward are available in Are limited to a small all currencies of number of currencies developed countries
  13. 13. 9. Why did the fixed exchange regime of 1945-1973 eventually fail? A. The Bretton woods systems worked without major changes from 1947 to 1971. During this period the fixed exchange rates were maintained by official intervention of the foreign exchange market. The system however suffered from a number of inherent structural problems. Firstly there was much imbalance in the roles and responsibilities of the surplus and deficit nations. Countries with persistent deficits in their balance of payments had to undergo tight and stringent economic policy measures if they wanted to take help from the IMF and stop the drain on their reserves. The basic problem here was the rigid approach adopted by the IMF to the balance of payments. From August-December 1971 most of the major currencies were permitted to fluctuate. Although the US dollar was not convertible into gold, it was still defined in terms of gold. The united States agreed to devalue the dollar from $35 per ounce of gold to $ 38 in return for promises from other members to up-value their relative to the dollar by specified. 10. How can a MNE minimize its translation and transaction exposure simultaneously? A. The methods for managing Translation exposure are i. Adjusted Fund flows: It involves altering either the amount of currencies or both cash flows of parent or subsidiary to reduce the firm‟s local currency exposure If local currency devaluation is expected then exports are priced in hard currency (foreign currency) and imports are priced in soft currency(local currency) ii. Entering into forward contracts: It demands a formal market in the respective local currency. Forward contract creates an offsetting asset or liability in the foreigncurrency the gain or loss on the transaction exposure is offset or liability in the foreign currency the gain or loss on the transaction exposure is offset by a corresponding loss or gain in forward market iii. Exposure rating: It refers to offsetting exposure in one currency with exposure in the same or another currency whose exchange rates rae expected to move in a way such that loss or gain on first exposed position will be offset by gain or loss to the second exposed position The methods of managing transaction exposure are Price adjustment Forward Market Money Market Currency Market Borrowing or lending in foreign currency
  14. 14. SECTION – C 1. Briefly explain the important factors that should be assessed from the pointsofview of Income tax, while entering into foreign collaboration agreement. A. i. Choose the right country: It is very essential to choose the right country fromwhere investment should be made. Such a choice would be depend upon the effective rate oftaxation in the hands of the foreign company on dividend income and capital gains taxincome. ii. Tax Credit: Double taxation avoidance agreements provide for tax credit in respect oftaxed paid in other country. Tax credit is normally a benefit which accrues to the foreigncollaborator and should be taken into account in fixing the consideration payable to theforeign collaborator. iii. Dependent service: Generally salaries, wages and other remuneration received by theforeign personnel deputed to India, are not taxable if the period of stay does not exceed 181days in the fiscal year. iv. Split up of total consideration payable to foreign party: In case of many treaties,different rates are provided for royalty and technical service fees. v. Take advantage vi. Tax Sparing: Tax sparing provisions in the treaties should be carefully considered. vii. Royalty via business profits: viii. Accommodation/living expenses provided to technicians 2. What do you mean by Depository Receipt and also explain the mechanism of depository receipt, what are its advantages. A. Depository Receipts is a negotiable certificate that usually represents a company‟s publicly traded debt or equity. Depository receipts are created when a broker purchases the company‟s shares on the home stock market and delivers those to the Depository‟s local custodian bank, which then instructs the depository bank, to issue Depository Receipts. Depository receipts are quoted and traded in the currency of the country in which they are trade and are governed by the trading and settlement procedures. The ease of trading and settling DRs makes them an attractive investment opinion for the investor wishing to purchase shares in the foreign companies.Depository receipts may trade freely, just like any other security, either on an exchange or in the over-the-counter market and can be used to raise capital. The most common DRs are the American Depository Receipts (ADRs) and the Global Depository Receipts (GDRs). A GDR is issued in America is called as American Depository Receipts (ADR). The mechanism for Depository Receipts
  15. 15. 5. What do you understand by the term “International Cash Management”? Briefly elucidate its objective. A. Cash management is an important aspect of working capital management and effectivecash management is one of the chief concerns of the MNCs. International cash managementis more complicated because it needs to recognise the principles and practices of othercountries. For example many countries require that their exporters repatriate the proceeds offoreign sales within a specific period or there could be a problem of blocked funds. Thisrestrictions hinder the free flow of capital and effective cash management. The Objectives of an effective International Cash Management Systems Minimise the country exposure risk Minimise the country political risk Minimise the overall cash requirements of the company as a whole without disturbing the smooth operations of the subsidiary or its affiliate Minimise the transactions costs Avoidance of foreign exchange losses Minimization of the tax burden of the firm as a whole Full benefits of economies of scale as well as the benefits of superior knowledge The complexity and problems in international cash management decisions arise due to theconflicting nature of the above mentioned objectives. For example minimizing transactioncosts of currency covers would require that cash balances be kept in the currency in whichthey are received, which conflicts with both the currency and political exposure criteria 6. Identify factors to be considered when assessing country risk. Briefly elaborate how each factor can affect the risk to the MNC. A. The factors that affect country risk can be of two types i. Political Risk Factors • Political Stability • Philosophy and Ideology of political parties • Integration into the world system • Ethnic and Religious Stability • Attitude of the Host Country Consumers • Disruptions in operations • Blockage of funds transfer by subsidiary to the parent firm • Loss of Intellectual Property rights • Economic source of political Corruption ii. Financial Risk Factors: • Current and potential economic health of the host country • Financial state of the host country • Monetary and Fiscal policies of the Host Country • Unproductive spending by the host country government Country Risk Analysing Technique Checklist Method Delphi Approach Statistical Techniques Spot Visits Combination of Techniques
  16. 16. 7. Describe briefly the distinguishing features of international finance. A. The distinguishing features of international finance are: i. Foreign Exchange risk ii. Political risks iii. Expanded opportunities iv. Market imperfections i. Foreign exchange risk: when different national currencies are exchanged for each other there is a definite risk of volatility in foreign exchange rates ii. Political risks: ranges from the risk of loss or gain from unforeseen government action. Since MNCs are exposed to more countries they are exposed to various types of political risks. iii. Expanded opportunities: when firms go global, they also tend to benefit from expanded opportunities which are available. They can raise money from markets where cost of capital is low. iv. Market Imperfections: the world markets are highly imperfect due to differences in the nations laws, tax system, business practices etc 8. Explain briefly the role of international finance manager. A. i. Making investment decisions: the finance manager has to identify profitable opportunities for a long term investment by using capital budgeting techniques. ii. Managing working capital: one very important role of international finance manager is management of current assets and liabilities and maintain an optimum working capital. iii. Making finance decisions iv. management of assets from cash management v. Exchange risk measurement vi. Performance evaluation and control 9. Explain the objectives and Functions of IMF. A. The objectives of IMF are a) To promote international monetary co-operation, exchange stability and orderly exchange arrangement b) To foster economic growth and a multilateral system of payments and transfers while
  17. 17. eliminating exchange restrictions c) To provide temporary financial assistance to countries to help ease balance of payments d) To facilitate the balanced growth of international trade and to contribute to high levels of employment, real income and productive capacity. e) To make financial resources available to members. The functions of IMF are: a) Surveillance: is the regular advice IMF provides for its member countries. b) Technical assistance: and training are offered mostly free of charge to help member countries strengthen their capacity to design and implement effective policies. c) Financial Assistance: is available to give member countries the chance to correct balance of payments problems. A policy program supported by IMF financing is designed by the national authorities in close co-operation with the IMF. 10. Briefly describe the evolution of the International Monetary System. OR What are the five basic mechanisms for establishing exchange rates? How does each work? A. The Gold Standard :This is the older state system, which was in operation till the beginning of the First World War and for a few years after that. In the version called Gold Specie Standard the actual currency in circulation consisted of gold coins with a fixed gold content. In a version called Gold Bullion Standard, the basis of money remains a fixed weight of gold but the currency circulation consists of paper notes with the authorities standing ready to convert on demand, unlimited amounts of paper currency into gold and vice versa, at a fixed conversion ratio. Thus a pound sterling note can be exchanged for say x ounces of gold, while a dollar note can be converted into say y ounces of gold on demand. Finally, under the Gold Exchange Standard, the authorities stand ready to convert, at a fixed rate, the paper currency issued by them into the paper currency of another country, which is operating a gold-specie or gold-bullion standard thus if rupees are freely convertible into dollars and dollars in turn into gold, rupee can be said to be on a gold-exchange standard. The exchange rate between any pair of currencies will be determined by their respective exchange rates against gold. This is the so-called "mint parity" rate of exchange. In practice because of costs of storing and transporting gold, the actual exchange rate can depart from this mint parity by a small margin on either side. Under the true gold standard, the monetary authorities must obey the following three rules of the game: - They must fix once-for-all the rate of conversion of the paper money issued by them into gold. - There must be free flows of gold between countries on gold standard. The money supply in the country must be tied to the amount of gold the monetary authorities have reserve. If this amount decreases, money supply must contract and vice-versa. The gold standard regime imposes very rigid discipline on the policy makers. Often, domestic considerations such as full employment have to be sacrificed in order to continue operating the standard, and the political cost of doing so can be quite high. For this reason, the system was rarely allowed to work in its pristine
  18. 18. version. During the Great Depression, the gold standard was finally abandoned in form and substance. In modern times, some economists and politicians have advocated return to gold standard precisely because of the discipline it imposes on policy makers regarding reckless expansion of money supply. As we will see later, such discipline can be achieved by adopting other types of exchange rate regimes. B. The Bretton Woods System Following the Second World War, policy makers from the victorious allied powers, principally the US and the UK, took up the task of thoroughly revamping the world monetary system for the non-communist world. The outcome was the so- called "Bretton Woods System” and the birth of two new supra- national institutions, the International Monetary Fund (the IMF or simply "the Fund") and the Word Bank- the former being the linchpin of the proposed monetary system. The exchange rate regime that was put in place can be characterized as the Gold Exchange Standard. It had the following features: - The US government undertook to convert the US dollar freely into gold at a fixed parity of $35 per ounce. - Other member countries of the IMF agreed to fix the parities of their currencies vis –`a - vis the dollar with variation within 1 % on either side of the central parity being permissible. If the exchange rate hit either of the limits, the monetary authorities of the country were obliged to "defend" it by standing ready to buy or sell dollars against their domestic currency to any extent required to keep the exchange rate withinthe limits. In return for undertaking this obligation, the member countries were entitled to borrow from the IMF to carry out their intervention in the currency markets. The novel feature of the regime, which makes it an adjustable peg system rather than a fixed rate system like the gold standard was that the parity of a currency against the dollar could be changed in the face of fundamental disequilibria. Changes of up to 10% in either direction could be made without the consent of the Fund while larger changes could be effected after consulting the Fund and obtaining their approval. However, this degree of freedom was not available to the US, which had to maintain gold value of the dollar. C. Exchange Rate Regimes: The Current Scenario The IMF classifies member countries into eight categories according to the exchange rate regime they have adopted. (1) Exchange Arrangements with No Separate Legal Tender: This group includes (a) Countries which are members of a currency union and share a common currency, like the eleven members of the Economic and Monetary Union (EMU) who have adopted Euro as their common currency or (b) Countries which have adopted the currency of another country as their currency. This latter group includes among others, countries of the East Caribbean Common Market (e.g. Grenada, Antigua, St. Kitts & Nevis), countries belonging to the West African Economic and Monetary Union (e.g. Benin, Burkina Faso, Guinea- Bisseau, Mali etc.) and countries belonging to the Central African Economic and Monetary Union (e.g. Cameroon, Central African Republic, Chad etc.). These two latter groups have adopted the French Franc as their currency. As of 1999, 37 IMF member countries had this sort of exchange rate regime. (2) Currency Board Arrangement: A regime under which there is a legislative commitment to exchange the domestic currency against a specified foreign currency at a fixed exchange rate, coupled with restrictions on the monetary authority to ensure that this commitment will be
  19. 19. honored. This implies constraints on the ability of the monetary authority to manipulate domestic money supply. As of 1999, eight IMF members had adopted a currency board regime including Argentina and Hong Kong Tying their currency to the US dollar. (3) Conventional fixed Peg Arrangements: This is identical to the Bretton Woods system where a country pegs its currency to another or to a basket of currencies with a band of variation not exceeding 1% around the central parity. The peg is adjustable at the discretion of the domestic authorities. Forty-four IMF members had this regime as of 1999. Of these thirty had pegged their currencies in to a single currency and the rest to a basket. (4) Pegged Exchange Rates within Horizontal Bands: Here there is a peg but variation is permitted within wider bands. It can be interpreted as a sort of compromise between a fixed peg and a floating exchange rate. Eight countries had such wider band regimes in 1999. (5) Crawling Peg: This is another variant of a limited flexibility regime. The currency is pegged to another other currency or a basket but the peg is periodically adjusted. The adjustments may be pre-an- enounced and according to a well specified criterion, or discretionary in response to changes in selected quantitative indicators such as inflation rate differentials. Six countries were under such a regime in 1999. (6) Crawling Bands: The currency is maintained within certain margins around a central parity. Which "crawls" as in the crawling peg regime either in a preannounced fashion or in response to certain indicators. Nine countries could be characterized as having such an arrangement in 1999. (7) Managed Floating with no Pre-announced Path for the Exchange Rate: The central bank influences or attempts to influence the exchange rate by means of active intervention in the foreign exchange market-buying or selling foreign currency against the home currency-without any commitment to maintain the rate at any particular level or keep it on any pre-announced trajectory. Twenty-five countries could be classified as belonging to this group. (8) Independently Floating: The exchange rate is market determined with central bank intervening only to moderate the speed of change and to prevent excessive fluctuations, but not attempting to maintain it at or drive it towards any particular level. In 1999, forty-eight countries including India characterized themselves as independent floaters. It is evident from this that unlike in the pre-I973 years, one cannot characterize the international monetary regime with a single label. A wide variety of arrangements exist and countries move from one category to another at their discretion. This has prompted some analysts to call it the international monetary "non-system". 11. Mention the different types of exchange rate system and explain them. A. The different types of A managed floating rate system is a hybrid of a fixed exchange rate and a flexible exchange rate system. In a country with a managed floating exchange rate system, the central bank becomes a key participant in the foreign exchange market. Under the managed
  20. 20. floating regime the central bank holds stocks of foreign currency known as the foreign exchange reserves Fixed (pegged) Exchange rate systems: The basic motivation for keeping exchange rates fixed is the belief that a stable exchange rate will help facilitate trade and investment flows between countries by reducing fluctuations in relative prices. Here the central bank stands ready to exchange local currency and at a pre-defined rate. Under the fixed exchange rate system the central bank remains prepared to absorb the excess of demand or supply. 13. Explain the foreign exchange market. A. The foreign exchange market is an over-the-counter market; this means that there is nosingle physical or electronic market place or an organized exchange (like a stockexchange) with a central trade clearing mechanism where traders meet and exchangecurrencies, The market itself is actually a worldwide network of inter-bank traders,consisting primarily of banks, connected by telephone lines and computers. The marketfunctions virtually 24 hours enabling a trader to offset a position created in one market usinganother market. The five major centers of inter-bank currency trading, which handle morethan two thirds of all forex transactions, are London, New York, Tokyo, Zurich, andFrankfurt. Transactions in Hong Kong, Singapore, Paris and Sydney account for bulk of therest of the market. Foreign Exchange Market Participants: The participants may include hedgers,arbitrageurs, speculators, institutional investors, individual investors and financial institutionssuch as commercial banks, investment banks , retail agents such as tourists, hotels etc. The market participants that comprise the FX market can be categorised into five groups:International banks , bank customers, non-bank dealers, FX brokers, and central banks. Mostinterbank trades are speculative or arbitrage transactions where market participants attempt tocorrectly judge the future direction of price movements in one currency versus anotherBid ask price: Bid price is the price to buy currency and ask price is the price to sellcurrency. The interbank market is a network of correspondent banking relationships withlarge commercial banks maintaining demand deposit account with another, calledcorrespondent bank accounts. The foreign exchange market is unique because: • Its trading volume • Its extremely liquidity in the market • The large number of and variety of traders in the market • The geographical dispersion • Its long trading hours: 24 hrs a day • The variety of factors that affect the exchange rate • The low margins of profit compared with other markets of fixed income.Central banks sometimes intervene in the foreign exchange market in an attempt to influencethe price of the currency against that of a major trading partner or country that it fixes or pegsits currency against.Bid-ask spread: The difference b/w the bid rate and ask rate is referred as the bid-ask rate. Ask rate - Bid rate Spread = x 100 Ask rateForeign Exchange rate: The rate at which the
  21. 21. home currency is exchanged for a foreigncurrencyDirect quote: is the number of units of home currency that can be exchanged for one unit ofa foreign currencyFor ex 1$ = Rs 45.54Indirect Currency: is the number of units of a foreign currency that can be exchanged forone unit of the home currency. For example 0.0022 Rs/S is an indirect quote.Forward rates of currency are either quoted as out- right rates or a discount/premium 20. Explain the various theories of exchange rate determination A. The various theories of exchange rate determination are Purchasing power parity (PPP) Fisher Effect (FE) International Fisher Effect (IFE) Interest rate parity (IRP) Purchasing Power ParityPurchasing power parity (PPP) was first stated in a rigorous manner by the Swedisheconomist Gustav Cassel in 1918.PPP has been widely used by central banks as a guide to establishing new par values for theircurrencies when the old ones were clearly in disequilibria. From a management standpoint,purchasing power parity is often used to forecast future exchange rates, for purposes rangingfrom deciding on the currency denomination of long- term debt issues to determining in whichcountries to build plants.In its absolute version, purchasing power parity states that exchange-adjusted price levelsshould be identical worldwide. In other words, a unit of home currency (HC) should have thesame purchasing power around the world. This theory is just an application of the law of oneprice to national price levels rather than to individual prices. (That is, it rests on theassumption that free trade will equalize the price of any good in all countries; otherwise,arbitrage opportunities would exist) However, absolute PPP ignores the effects on free tradeof transportation costs, tariffs, quotas and other restrictions, and product differentiation.The relative version of purchasing power parity, which is used more commonly now,states that the exchange rate between the home currency and any foreign currency will adjust to reflect changes in the price levels of the two countries. For example, if inflation is 5% inthe United States and 1 % in Japan, then in order to equalize the dollar price of goods in thetwo countries, the dollar value of the Japanese yen must rise by about 4%. The Fisher effect states that the nominal interest rate r is made up of two components: (I) areal required rate of returns a and (2) an inflation premium equal to the expected amount ofinflation i. Formally, the Fisher effect is1 + Nominal rate = (l + Real rate)(l + Expected inflation rate)1 + r = (1 +a) (l +i)orr = a + i + aiIn equilibrium, then, with no government interference, it should follow that the nominalinterest rate differential will approximately equal the anticipated inflation rate differential, or (1+rh ) / (1+rf ) = (1+ih ) / (1+if )where rh and rf are the nominal home- and foreign-currency interest rates, respectively.If rf and if are relatively small.In effect, the generalized version of the Fisher effect says that currencies with high rates ofinflation should bear higher interest rates than currencies with lower rates of inflationThe International Fisher EffectThe key to understanding the impact of relative changes in nominal interest rates amongcountries on the foreign exchange value of a nations currency is to recall the implications ofPPP and the generalized Fisher effect. PPP implies that exchange rates will move to offsetchanges in inflation rate differentials. Thus, a rise in the U.S. inflation rate relative to those ofother countries will be associated with a fall in the dollars value. It will also be associatedwith
  22. 22. a rise in the U.S. interest rate relative to foreign interest rates.Combine these two conditions and the result is the international Fisher effect:(1 + rh) t / (1 + rf ) t = et / e0where et is the expected exchange rate in period t. The single period analogue to aboveEquationis(1 + rh) / (1 + rf ) = e1 / e0Note the relation here to interest rate parity. If the forward rate is an unbiased predictor ofthe future spot rate-that is,f l = e1 -then Equation becomes the interest rate parity condition:(1 + rh) / (1 + rf ) = f1 / e0 Interest rate parity (IRP): The interest rate parity is the basic identity that relates interestrates and exchange rates. It states that the returns from the borrowing in one currencyexchanging that currency for another currency.Interest rate parity is a relationship that must hold between the spot interest rate of twocurrencies if there are to be no arbitrage opportunities. The relationship depends upon spotand forward exchange rates between the two currencies m f 1 + r a  =  S  1 + rb  where S– spot rate f- forward rate , ra and rb are the interest rates for therespectivecurrenciesTheory Key variables of theory Summary of TheoryInterest Rate parity (IRP) Forward rate Interest The forward rate of one premium or differential currency with respect to discount another will contain a premium (or discount) that is determined by the differential in interest rates between the two countries. As a result, covered interest rate arbitrage will provide a return that is no higher than a domestic returnPurchasing Power Percentage Inflation The spot rate of one currencyParity(PPP) change in the rate with respect to another will spot exchange differential change in reaction to the rate differential in reaction to the differential in inflation rates between the two countries. Consequently the purchasing power for consumers when purchasing goods in their own country will be similar to their purchasing power when importing goods from the foreign countryInternational Fisher Effect Percentage Interest rate The spot rate of one currency(IFE) change in the differential with respect to another will spot rate change in accordance with the differential in interest rates between the two countries. Consequently the return on uncovered foreign money market securities will on an average be no higher than the return on the domestic money market securities from the perspective of investors in the home country 14. Explain briefly the four methods of Translation exposure. A. The four methods of foreign currency translation are i. The current rate method ii. The monetary/non-monetary method iii. The temporal method iv. The current /non-current method i. The current rate method: All items of the balance sheet and income statement are translated at the current spot rate exchange ii. Monetary and Non-monetary method: Under this method monetary items are translated at the current spot exchange rate and the no-monetary items are translated at the historical rates. iii. The temporal method: Under this method if an item is originally stated at historical cost its translation is carried out at the historical spot rate of exchange. If the item is originally stated at
  23. 23. its market value the translation is carried out at the current spot exchange rate. iv. The current/Non-current method: According to this method all the current assets and current liabilities of a foreign subsidiary are translated into the home currency of the parent company at the current spot exchange rate. In non-current asset or liabilities are translated at historical rate of exchange. 15. Describe the various methods of capital budgeting that are normally adopted byMNCs A. Once a firm has compiled a list of prospective investments, it must then select from amongthem that combination of projects that maximizes the companys value to its shareholders.This selection requires a set of rules and decision criteria that enables manager‟s e todetermine, given an investment opportunity, whether to accept or reject it. It is generallyagreed that the criterion of net present value is the most appropriate one to use since itsconsistent application will lead the company to select the same investments the shareholderswould make themselves, if they had the opportunity. Net Present ValueThe net present value (NPV) is defined as the present value of future cash flows discounted atan appropriate rate minus the initial net cash outlay for the project. Projects with a positiveNPV should be accepted; negative NPV projects should be rejected. If two projects aremutually exclusive, the one with the higher NPV should be accepted. The discount rate,known as the cost of capital, is the expected rate of return on projects of similar risk. Fornow, we take its value as given.In mathematical terms, the formula for net present value is nNPV = - I0 + Σ CFt / (1 + K)t t=1Where I0 = the initial cash investmentCFt = the net cash flow in period tk = the projects cost of capitaln = the investment horizonThe most desirable property of the NPV criterion is that it evaluates investments in the sameway the companys shareholders do; the NPV method properly focuses on cash rather than onaccounting profits and emphasizes the opportunity cost of the money invested. Thus, it isconsistent with shareholder wealth maximization.Another desirable property of the NPV criterion is that it obeys the value additively principal.That is, the NPV of a set of independent projects is just the sum of the NPVs of the individual projects. This property means that managers can consider each project on its own. It alsomeans that when a firm undertakes several investments, its value increases by an amountequal to the sum of the NPV s of the accepted projectsThe NPV of a project is the present value of all cash inflows, including those at the end of theproject‟s life, minus the present value of all cash outflows.The decision criteria is to accept a project if NPV≥ 0 and reject if NPV< 0The Adjusted Present Value (APV) FrameworkThe APV framework" allows us to disentangle the financing effects and other special featuresof the project from the operating cash flows of the project. It is based on the well-knownvalue additively principal. It is a two-step approach:1. In the first step, evaluate the project as if it is financed entirely by equity. The rate ofdiscount is the required rate of return on equity corresponding to the risk class of the project.2. In the second step, add the present values of any cash flows arising out of special financingfeatures of the project such as external financing, special subsidies if any, and so forth. Therate of discount f used to find these present values should reflect the risk associated with eachof the cash flows.In APV approach each cash flow is discounted at a rate of discount consistent with the riskinherent
  24. 24. in that cash flow n CFt n Tt APV = I0 + ∑ t ∑ + t+ 1 (1 + k ) t+ 1 (1 + id )tWhere T – tax savings id = cost of debt 16. Discuss the difference between cost of capital for MNCs and domestic firms. A. The difference between cost of capital for MNCs and domestic firms include :i. Size of the firms: Firms that operate internationally are usually much bigger in size thanfirms which operate only in domestic market. ii. Foreign exchange risk: A firm more exposed to exchange rate fluctuations would have awider spread of possible cash flows in future periods. Thus exposure to exchange ratefluctuations could lead to higher cost of capital. iii. Access to international capital markets: The fact that MNCs can normally access theinternational capital market helps them to attract funds at a lower cost than the domesticfirms. This form of financing helps to lower the cost of capital and will generally not increasethe MNCs exposure to exchange rate risk. iv. International diversification effect: If a firm‟s cash inflows come from sources all over theworld , there might be more stability in them. MNCs by their virtue of their diversificationoperations, can reduce their cost of capital compared to domestic firms v. Political risk: can be accounted for in the cost of capital calculations by adding an arbitrary risk premium to the domestic cost of capital for a project of comparable risk. vi. Country risk: Country risk represents the potentially adverse impact of a country‟s environment on the MNCs cash flows. If the country‟s risk level of a particular country increase, the MNC may consider divesting its subsidiaries located there. vii. Tax Concessions: MNCs generally choose countries where the tax laws are favourable for them as their net income is substantially influenced by the tax laws in the locations where they operate. 17. Explain the distinguishing features of multinational cash management and discussthe techniques used to optimise cash flows. A. Though the principles of domestic and international cash management are the sameinternational cash management is wider in scope and is more complicated because it needs torecognise the principles and practices of other countries. Other important complicatingfactors in international cash management include multiple tax jurisdictions and currenciesand the
  25. 25. relative absence of internationally integrated interchange facilities as are availabledomestically in the United States The basic objectives of an effective international cash management system are: 1. Minimise the currency exposure risk. 2. Minimise the country and political risk 3. Minimise the overall cash requirements of the company as whole without disturbing the smooth operations of the subsidiary or its affiliate 4. Minimise the transactions costs 5. Full benefits of economies of scale as well as the benefit of superior knowledge A centralised cash management group may be needed to monitor and manage the parentsubsidiary and inter-subsidiary cash flows. International cash management requires achieving two basic objectives: 1. Optimising cash flow movements 2. Investing excess cashTechniques to optimise cash flow The various ways by which cash inflows can be optimised are: 1. Accelerating cash inflows 2. Managing blocked funds 3. Leading and lagging strategy 4. Using netting to reduce overall transaction costs by eliminating a number of unnecessary conversions and transfer of currencies 5.Minimising the tax on cash flow through international transfer pricing Accelerating cash inflows: is the first objective in cash management, quicker recovery ofinflows assures that they are available with the firm for use or for investment Managing blocked funds: the host country may block funds that the subsidiary attempts tosend to the parent. The parent may also instruct the subsidiary to obtain financing from alocal bank rather than from the parent. This also helps the subsidiaries as they may be able tobetter utilise blocked funds by repaying the local loan. Leading and Lagging: The leading and lagging technique can be used by subsidiaries foroptimising cash flow movements by adjusting the timing of payment to reflect expectationsabout the future currency movements. MNCs can accelerate (lead) or delay(lag) the timing offoreign currency payments by modifying the credit terms extended by one unit to
  26. 26. another.Leading and lagging is adopted by MNCs in order to reduce foreign exchange exposure or toincrease available working capital. Netting: Netting is a technique of optimising cash flow movements with the joint efforts ofsubsidiaries. The process involves the reduction of administration and transaction costs thatresult from currency conversion. Advantages of Netting: • It reduces the number of cross-border transactions between subsidiaries thereby reducing the overall administrative costs of such cash transfers. • The technique reduces the need for foreign exchange conversion and hence reduces transaction costs associated with foreign exchange conversion • It helps in improved cash flow forecasting since only net cash transfers are made at the end of each period Netting is of two types: 1. Bilateral Netting setting: A bilateral netting system involves transactions between the parent and a subsidiary or between the two subsidiaries. 2. Multilateral Netting: Under a multilateral netting system, each affiliate nets all its inter- affiliate receipts against all its disbursements. It then transfers or receives the balance, depending on whether it is a net receiver or a payer. A multinational netting system involves a more complex interchange among the parent and its several affiliates but it results in a considerable saving in exchange and transfer costs. However for multinational netting to be effective there is a need for centralised cash management from the side of MNCs. An effective cash management system should be based on a cash budget that projectsexpected cash inflows and outflows over some planning horizon. 18. What are the fundamental considerations which are taken into consideration whileevaluating Foreign projects. A. The basic steps involved in evaluation of a project: • Determine net investment outlay • Estimate net cash flows to be derived from the project over time, including an estimate of salvage value. • Identify the appropriate discount rate for determining the present value of the expected cash flows • Apply NPV or IRR techniques to determine the acceptability or priority ranking of potential projects