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International financial management


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International financial management

  1. 1. Multinational Corporations:- The essential nature of multinational enterprise lies in the fact that its managerial headquarters are located in one country (home country)while enterprise carries out operations in a number of other countries as well(host countries) “ a corporation that controls production facilities having been acquired through the process of foreign direct investment—ILO report observes MNC meets five criteria :-1.It operates in many countries at different levels of economic development 2.Its local subsidiaries are managed by nationals 3it maintains complete industrial organizations which include R&D, manufacturing facilities in several countries 4.It has multinational central management 5.It has multinational stock ownership
  2. 2. A transnational corporation is a multinational in which both ownership and control are dispersed ,internationally .There is no principle domicile and no one central source of power Eg. Royal Dutch,Shell,Unilever A global corporation is one which views the entire world as a single market which should be catered to by globally standardized products Characteristics of MNCs:- 1 .Giant size-Asset & sales of MNC 2.International Operation – It runs its operations through network of branches &subsidiaries 3Oligopolistic Power-Process of merger & takeover of other firm 4.Centralized control- Headquarters in the home country 5.Collective Transfer of resources – Technical know –how ,raw materials, management expertise, machinery,etc 6.International Market
  3. 3. Reasons for growth of MNCs :-Benefits to them &their home Countries –1. MNC can exploit the foreign markets. Export from home country increase. 2.MNC get income from abroad like dividends, royalties etc 3.MNC can acquire raw materials at cheaper rate 4.Export spare parts for assembling & selling in the foreign market 5.MNC-integratingnational economies into universal system The inflow of capital from abroad -1.FDI includes investment by braches, subsidiaries, affiliates of foreign companies 2.Portfolio investment- comprise equity holdings by nonresident In Indian companies debt capital from foreign sources in Indian companies
  4. 4. Benefits Achieved by host countries 1.Transfer of Technology 2.HR Development 3Health competition 4Foreign Capital 5.R&D 6.Employment opportunities Benefits to Home countries 1.Huge revenue 2.cheaper raw materials 3.utillize talents 4 Generate employment
  5. 5. Foreign Exchange Market:-Foreign exchange arises out of international trade .Foreign exchange is the system or process of converting one national currency into another, &of transferring money from one country to another” Paul Einzing The foreign exchange market is the market in which individuals firms & banks buy & sell foreign currencies or foreign exchange. Four levels of transactors or participants can be identified in foreign exchange markets. First levels are tourists, importers, exporters, investors etc, second level are the commercial banks which act as clearing houses between users &earners of foreign exchange .Third level are foreign exchange brokers. The final level is central bank ,acts as seller or buyer of last resort
  6. 6. Segments of foreign exchange Market:-1.Over the Counter(OTC) market &2.Exchange traded market 1.Over the counter market –OTC It is an informal arrangement among the banks &brokers operating in a financial centre buying &selling currencies connected to each other by telex, telephone, satellite communication net work Eg. RBI, it comprises both Commercial banks & investment banks, financial institutions 2.Exchange Traded Market – comprises of securities exchange, future &options are traded Functions of Exchange Market:- 1. Currency conversion 2.Provision of credit: Exporters &Importers get pre -shipment & Post -shipment credit, ECGC gives loan(Expo. Credit Guaran corp. 3.Insurance against foreign exchange risk:-Foreign Exchange Market provides insurance to protect against the possible adverse Consequences of unpredictable changes in exchange rates
  7. 7. Instruments of foreign Exchange-:1.Spot rate: -It is the exchange Rate quoted for transactions that require ether immediate delivery or delivery with in two days 2.Forward rate :-The transaction which involves the exchange of Currencies beyond three days at a fixed exchange rate. It can be for one month or three months etc. A forward contract for delivery one month means the exchange currencies will take place after one month from the date of contract 3.At par- If the forward exchange rate quoted is exactly equivalent to the spot rate at the time of making the contract. 4.Arbitrage :-The exchange rate between any two currencies is kept the same in different monetary centers by arbitrage. This refers to the purchase of currency in the monetary centre where it is cheaper ,for immediate resale in the monetary centre where it is more expensive in order to make profit
  8. 8. 5.Currency swap:-A currency swap refers to a spot sale of currency combined with a forward repurchase of the same currency – as a part of single transaction. 6.Hedging:-A transaction strategy used by traders and investors In foreign exchange to protect an investment or portfolio against currency price fluctuations. A current sale by or purchase is offset by contracting to purchase or sell at specified future date in order to defer a profit or loss on the current sale or purchase. In this way risk due to currency price fluctuations is reduced Factors influence the rate of exchange :1.Trend in foreign trade 2.Capital Movements. 3.Speculative activities 4.Bank rate 5.Govt control . 6.Miscellaneous factors
  9. 9. 1.Trend in foreign trade:- Exports &other services rendered to another country will bring foreign exchange for the country. If exports exceed the imports exchange rate will change to be favourable to the country while excess of imports over the exports will make the rate of exchange unfavorable to the country .The changes in foreign trade of the country lead to the fluctuations in the rate of exchange. 2.Capital Movements:-Capital movements in the form loans of & investment between the countries also influence the exchange rates. Sometimes large scale capital movements take place through stock exchange transactions. If home investors purchase securities ,the demand for foreign currencies will go up & exchange rate will become unfavourable. If foreigners buy securities floated in the country ,the rate of exchange will become favourable
  10. 10. Speculative activities:- Speculators in exchange markets who buy a currency from centres where it is cheap ,with a view to sell it where it is high and thereby make profits Similarly people expect the price of currency will go up so they buy the currency to make profit in future 4.Bank rate:-High bank rate will attract fund from foreign countries, then rate exchange will be favourable &vice versa 5Currency &Credit condition;-These are influenced by the monetary policy of the country. If the supply of currency & bank credit increases over number of years it will affect export and increase the import 6.Government control:-Govt . should control all the foreign exchange transaction in the country – Need stability of Govt 7.Miscellaneous factors:-stability ,prestige, respect of currency will play a big role in the world market
  11. 11. Balance of Payment:-Balance of payment is a systematic record of all transactions between the residents of country &the rest of the world during a given period .Credit side shows Receipts of foreign exchange from abroad and the debit side shows payments in foreign exchange to foreign residents. Receipts and payments are in two heads – one being the current account and the other being the capital account. The current account represents transfer of real income and the capital account is only transfer of funds without effecting a shift in real income. Current Account Transactions are those relating to export and import of services, income on investments and unilateral payments (gifts, remittances for family maintenance, etc).
  12. 12. Current Account records the receipts & payments of foreign exchange in the following ways:- 1. Current account receipts -> (i) Export of goods (ii) Invisible (services, unilateral transfers, investment income) (iii) Non – monetary movement of gold 2. Current Account Payments -> (i) Import of goods (ii) Invisible (services, unilateral transfers, investment income) (iii) Non – monetary movement of gold Export of goods will bring foreign exchange in the country & the import of goods causes outflow of foreign exchange from the country. The difference between these two is known as balance of trade.
  13. 13. If the credit side is greater than debit side, the difference shows current account surplus. Thus, representing net foreign investment (If). If > 0 (Nation is investing part of its savings (S) abroad instead of in domestic capital formation (Id)) Current account surplus = X-M (Export - Import) On the contrary, if the debit side >credit side, which indicates current account deficit. Thus, nation is disinvesting abroad. Current account deficit = import > export Invisibles & Current Account The key drivers of invisible receipts were travel earnings, software exports and workers’ remittances.
  14. 14. Capital Account Transaction:-The capital account transactions take the following ways :-1.Capital Account receipts >1.Long term Inflow funds (2) Short term inflow funds 11. Capital account payments :-1.Long term outflow fund (2) Short term outflow of funds Capital account receipts :The long term maturity is over one year, while in the short term flows are effected one year or less The credit side records the official &private borrowing from abroad net of repayments, direct and portfolio investment & short term investments into the country. It records the bank balances of the non residents held in the country. The debit side includes disinvestments of capital, country’s investment abroad, loans given to foreign government or a foreign party and bank balances of the non-residents held in the country.
  15. 15. Movement of gold may be monetary or non monetary. Monetary movement is the sale or purchase that influences the international monetary reserves. Non monetary sale and purchase of gold is done for industrial purposes that is shown in the current account either separately or along with the trade in merchandise When credit side of the current account along with the credit side of the long term capital account transactions is compared with the transactions on the debit side of the current account Plus the long term capital account, the difference is known as the basic balance which may be negative or positive The debit and credit sides of short term capital transactions are added to their respective sides and then capital account is balanced. After balancing the capital account errors and omissions are mentioned .Finally two sides are compared. The difference is known as overall balanced
  16. 16. Balance of trade =Export of goods - Import of goods Balance current a/c =Balance trade +net earning on invisibles Balance of Capital a/c =Foreign exchange inflow – foreign exchange outflow, (on account of foreign investment, foreign loans, banking transactions & other capital flows) Overall balance of payments = Balance of current + balance of capital account +statistical discrepancy Statistical discrepancy is known as errors and omissions Official Reserve Account :- Official reserves are held by the monetary authorities of a country .It consists of monetary gold, SDR allocations by IMF &foreign currency assets. If overall BOP is surplus, the surplus amount adds to the official reserve account. If BOP is deficit & if accommodating capital is not available the ,official reserve account is debited by the amount of deficit.
  17. 17. Country A :-Balance of payments1998-99 (Rupees) Credit Debit Balance A . Current Account Merchandise import - ------- -------------- 120 Merchandise export ------------- 100 Balance of trade (120-100) --------- -------------------------- -20 Invisibles Services (net ) -------------------------- 4 Unilateral transfers (net)-------------------- 2 Invest income (net) - ----- ---------------- ------------ 1 Non monetary movement of gold(net) --- ------------ Balance of current account --(4 +2) -1=5 –(-20 ) ………. -15 B.Capital Account -- Long –term Direct investment abroad ---------------------------- 11 Direct foreign investment inflow -- ------ 18 Portfolio investment(net)------------------ 9 Loans-official & private net repayment 12 Basic balance (100+4+2+18+12 =(136) (120 + 11 +9 +1 ) =(141 ) >136-141 ---------------------- -5
  18. 18. Capital Account ---Short term Credit - Debit - Balance Holdings with banks --------------- 4 Other short term transactions --------------------- 3 Balance of capital account (foreign exchange inflow – outflow) (18+12+4) =34 -23 (11+9+3) ------------------------ 11 C. Errors& Omissions -1 Overall Balance (Balance of current account + Balance of capital a/c + statistical discrepancy )(errors omission) (-15) + (11)= - 4 +(-1) --------------------------------- -5 D. Official Reserves SDR (other short term transactions)-- 3 Net official reserves -------------------- 2 Overall balance ----- ----------------------------------- -5 Office Reserves Movement ………….. 5
  19. 19. International Bond Market :-The international bond market(IBM) encompasses two basic markets segments :foreign bonds and Eurobonds. A foreign bond issue is one offered by a foreign borrower to the investors in a national capital market and denominated in that nation’s currency. Eg A German MNC is issuing dollar denominated bonds to US investors A Euro bond issue is one denominated in a particular currency but sold to investors in national capital market other than the country that issued the denominating currencies A Dutch borrower issuing dollar denominated bonds to investors in UK or Netherlands..Roughly 80% of new international bonds are likely to be Eurobonds rather than foreign bonds. Euro bonds are known by currency in which they are denominated Eg.Yen Euro bond, Us.$ Eurobonds. Yankee bonds are dollar denominated foreign bonds originally sold to US
  20. 20. Euro bonds are usually bearer bonds. With bearer bond possession is evidence of ownership. With registered bond the owner’s name is on the bond & it is also recorded by issuer. When registered bond is sold a new bond certificate is issued. National Security regulation Foreign bonds must meet the security regulations of the country in which they are sold. But Eurobond in the USA may not be sold to US citizens. After 90 days US investor can buy from the secondary market Withholding taxes Prior to 1984 ,the USA required on interest 30%withholding tax on interest paid to nonresidents who held US Govt or corporate tax .Moreover, US. firms issuing Eurodollar bonds from the US were required to withhold the tax on interest paid to foreigners
  21. 21. Other Recent regulatory changes:-Two other recent changes in US security regulations have had an effect on the international bond market. One is Rule 415,which the SEC (Securities & Exchange Commission) instituted in1982 to allow shelf registration. Shelf Registration allows an issuer to pre-register a securities issue,& then shelve the securities for later sale when financing is actually needed. In 1990 the SEC instituted Rule 144,which allows qualified institutional investors in the Us that do not trade in private Placement issues that do not have to meet the strict Information disclosure requirements of publicly traded issues Global bond Global bond issues were first offered in 1989.A Global bond issue is very large international bond offering by a single borrower that is simultaneously sold in North America, Europe ,&Asia
  22. 22. Types of Instruments: IBM has been much more innovative than the domestic bond market in the types of instruments offered to investors 1. Straight fixed –rate bond issues:-These have a designated maturity date at which the principal of the bond is promised to be repaid. During the life of the bond fixed coupon payments are Paid as interest to the bond - holders. The Us $,UK sterling pounds Japanese Yen have been denominating straight fixed rate bond. 2. Euro-Medium –Term Notes(Euro MTNs) :-These are fixed rate notes issued by corporation with maturities ranging from less than a year to about 10yrs.Euro-MTNs have a fixed maturity and Pay coupon interest on periodic dates. 3. Floating-rate Notes(FRN). It was introduced in 1970.Floating rate notes are medium –term bonds with coupon payments indexed to Some reference rate. Common reference rates are either three month or six month Us dollar LIBOR(London inter bank Offered Rate, used as the basis for setting euro currency loan rates )Coupon payments on FRNs are usually quarterly or semiannual with reference rate
  23. 23. 4.Equity –Related Bonds:-There are two types of equity-related bonds. They are Convertible bonds &bonds with equity warrants. A convertible bond issue allows the investor to exchange the bond for a predetermined number of equity shares of the issuer. The floor- value of a convertible bond is its straight fixed rate bond value. 5.Bonds with equity warrants can be viewed as straight fixed rate with the addition of a call option (or warrant ) feature. The warrant entitles bondholder to purchase a certain number of equity shares in the issuer at a pre stated price over a Predetermined period of time. 6.Zero coupon bonds:-The bonds are sold at a discount from face Value & do not pay any coupon interest over their life. At maturity the investor receives the full face value. The zero coupon bonds have been denominated primarily in the US$ &Swiss franc. Japanese investors are attracted to Zero coupon bonds because of tax free capital gain
  24. 24. 7.Another form of zero coupon bonds are stripped bonds. A stripped bond is a zero coupon bond that results from stripping the coupons and principal from coupon bond. The result is a series of zero coupon bonds represented by individual coupon principal and payments. The stripped bonds are actually receipts representing a portion of the Treasury security held in trust .In 1985 the US Treasury introduced its own product called STRIPS. 8.Dual –Currency:-A dual currency bond is a straight fixed rate bond issued in one currency ,Eg Swiss francs that pays coupon Interest in that same currency. At maturity the principal is repaid in another currency,ie Us$. If the dollar appreciates over the life of the bond, the principal repayment will be worth more than a return of principal in Swiss francs
  25. 25. International portfolio Investment:-The rapid growth in international portfolio investments in recent yrs reflects the globalization of financial markets. The investors can reduce the risk when they diverse their portfolio holdings internationally than domestically. Security returns are much less correlated across countries than within a country. So international diversification can sharply reduce risk. Rational investors would select modes of portfolios by Considering returns as well as risk. 1.International mutual funds 2.Country fund & 3.internationally cross-listed stocks, which allow investors to achieve international diversification without incurring excessive costs. The Uk market performed well ranking fourth, owing to the respectable mean return combined with relatively low risk.
  26. 26. International Bond investment:-In the optimal international portfolio, the US bond receives the largest positive weight, followed by French &Japanese bonds. The investors may be able to increase their gains from international bond diversification if they can properly control the exchange risk. The euro currency is likely to alter the risk return characteristics of the affected markets. The British bonds would play an enhanced role in international diversification strategies to retain their risk return role. International Mutual Funds:-By investing IMF, investors can 1.Save any extra transaction and or information costs they may have to incur when they attempt to invest directly in foreign markets. 2.Potentially benefit from the expertise of professional fund manages 3.Many legal & institutional barriers to direct portfolio investments
  27. 27. In addition to International mutual funds, investors may achieve International portfolio diversification by investing in 1.Country Funds,2.American depository receipts(ADRs) , equity benchmark shares (WEBS),without having to invest directly in foreign markets. Using country funds, investors can -1.Speculate in a single foreign market with minimum costs. 2.Construct their own Personal international portfolios using country funds as building blocks . 3.Diversify into emerging markets that are otherwise practically inaccessible Many emerging markets, country funds provide international investors with the most practical, if not the only, way of diversifying into these largely in accessible foreign markets.
  28. 28. The majority of country funds available ,however, have a closed end status, A closed –end country fund (CECF) issues a given number of shares that trade on the stock exchange of the host Country 2.International Diversification with ADRs :-US investors can achieve international diversification at home using American Depository Receipts (ADRs) and country funds. ADRs represent receipts for foreign shares held in the US depository banks in foreign branches or custodians. ADRs are traded on US exchange like American securities 3.International Diversification with WEBS:In April 1990 American Stock Exchange introduced World Equity Benchmark Shares (WEBS).Before this US introduced Standard &Poor’s Depository Receipts(SPDRs) known as Spiders. WEBS&Spiders are exchange traded open funds so investors can trade stock market index
  29. 29. The investors allocate a disproportionate share of their funds to domestic securities, displaying so called home bias . Home bias is likely to reflect imperfections in the international financial markets like excessive transactions. The portfolio combining equity shares & bonds is preferable to investment in equity alone or in bonds alone because the combination of equity & bonds raises the risk- adjusted return. Cross –Boarder Listings of Stocks:- Cross boarder listings of stocks have become quite popular among major corporations. Novo Industry-Danish Multinational corporation –produces health care products like insulin listed its stock in Newyork Stock Exchange-they directly raise equitycapital in USA.In1970 they decided to enter into international capital market from the Danish stock market.Then they faced higher cost of capital than competitors. Again they decided to low its capital For that they issued euro bond ,listed in London stock exchange in 1978.Followed This they sponsored ADR.US investors could invest.The Sharp increse in Novs price indicated stock became fully priced internationally
  30. 30. Evaluation Criteria-:- Non Discounting Methods