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INTERNATIONAL
FINANCIAL
MANAGEMENT

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SYLLABUS
333- INTERNATIONAL FINANCIAL MANAGEMENT
UNIT 1:
International Financial System: Meaning, scope and significance of International
Finance. International Financial System Components and environment. Finance
function in global context International Monetary System fixed and floating
systems Balance of Payments (BOP). International Financial Institutions World
Bank IMF ADB
UNIT II:
Foreign Exchange Market: Players and components, functions Foreign Exchange
Rates Spot Forward and Cross Rates. Theories of determining foreign exchange
rate International Parity condition. Indian Foreign Currency Market Foreign
Exchange Management Act (FEMA) Recent development (Problems and cases).
UNIT III:
Management of Foreign Exchange Risk: Meaning and types of risk Management of
Translation, Transaction, and economic exposure. Tools, Techniques and Hedging
strategies for foreign exchange risk management
UNIT IV:
International Monetary System: Forwards, Swaps, and interest rate futures.
European Monetary markets, Asian Currency Markets, GDRs, ADRs, Blocked
Accounts, Dealing position, Speculation and leveraged arbitrage
UNIT V:
Financial Management of Multinational Firm Foreign Capital Budgeting Decisions
Cash Flow Management Tax and Accounting implications of International activities

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UNIT I

INTERNATIONAL FINANCIAL SYSTEM

INTRODUCTION:
The domestic financial system consists of 4 basic elements. They are given as
i.

Financial Markets

ii.

Market Participants

iii.

Financial Claims

iv.

Market facilitators or regulators

Where as the international financial system consists of the following elements:

i.

The exchange of goods and services involving payments and receipts as between
countries.

ii.

The exchange of one currency for another.

iii.

Borrowing and lending of money across borders.

iv.

Trading in foreign currencies and foreign assets or liabilities and claims.

Difference between International and Domestic financial system:

The international financial system differs from domestic financial system in the
following aspects:
i.

Transactions in foreign currencies.

ii.

Financial dealings outside of nations boundaries.

International Financial Management

Domestic Financial Management

1) Investments are made internationally

1) Investments are retained in the

2) Desire for high expansion and are more

domestic (home) country only

ambitious

2) Less ambitious so less expansion

3) Competition is more as it goes globally

3) Competition is less

4) High risk is faced in the global market

4) Less Risk

5) Large investments are made in

5) Less investments are made for research

Research and development

and development

6) Supply and Demand goes global.

6) Supply and demand is limited to home

country

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Meaning of International Financial System:

International Financial System deals with the financial decisions taken in the area
of international business. International financial management can be traced to the sectored and
national interdependence which leads to international economic, commercial and financial
relations in between countries. International trade aid and financial flows account for bulk of
such transactions in between nations.
Thus international financial management as occupied an important row of the
Indian economy with Foreign Investment Institutions (FIIs) and Foreign Direct Investment
(FDIs) playing a key role in the stock end capital market. Thus the study of financial
management has become significant and it covers:
Foreign exchange markets
MNCs financial Investments
Financial investment decisions of MNC (Multinational Company)
International accounting and taxation
International working capital Decisions
SCOPE AND SIGNIFICANCE OF INTERNATIONAL FINANCIAL MANGEMENT:
SCOPE:
International financial management is concern with the financial aspects of international
business. International financial management has a wider scope than domestic corporate finance
and it is designed to cope with greater range of complexities with the acceptance of the policy of
economic liberalization and globalization and this led to the fast expansion in international trade
in the activities of MNCs and in international financial market.
To handle international transactions effectively, it is important to have qualified and
trained personnel, this is one reason to gain importance in the area of international financial
dealings.
SIGNIFICANCE:
The international financial management benefits and significant in following ways:
It helps in taking correct financial decisions so that the maximum can be derived from
international business in any mode of situation.
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International events affect the firms and what steps to grab opportunities from positive
developments and insulate from harmful ones.

Recognize how the firm will be affected by movement in exchange rate, interest rates,
inflation rate.

INTERNATIONAL FINANCIAL SYSTEM ENVIRONMENT:

Global environment factors effecting the international financial environment
Economic and financial factors:
Example: Recession, boom conditions in trading, inflation rate, interest rate etc
Political and government policies:
Example: Monitory policies, fiscal policies and political stability etc
Social and cultural factors:
Example: Spirit of swadeshi, social habits and customs, belief of culture etc
Demographic factors:
Example: Size of the country, population, age, wages, land etc
Natural Environment:
Example: Natural resources, weather & climate conditions and infrastructural factors
Technological Environment:
Example: E- marketing, internet facilities, mobile phones etc
COMPONENTS OF INTERNATIONAL FINANCIAL MANAGEMENT:
The major components of international financial system are as follows:
1. Foreign Exchange Market: In this the exchange of goods and services are done for
currencies.
2. Foreign currency market: In this market the currencies are borrowed and lent.
3. Swap market: Swap is an agreement for exchange of forward dollars for spot dollars and
vice versa or floating instruments for a fixed cost instrument.
4. Derivatives market: This market is classified into Futures and Options
5. International Financial Market: This market is sub classified into:
a) Foreign equity market: In this market the equities are traded globally for raising
of money in the foreign market.
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b) Foreign bond market: In this the amount is raised in the form of bonds in foreign
market.
6. International Money Market: This is further classified into:
a) Euro currency market: In this the European currencies are borrowed and lent.
b) Euro bond market: The amount raised in the form of Euro bonds.
c) Asian currency market: Asian dollars are borrowed and lent.

FINANCE FUNCTIONS IN GLOBAL CONTEXT:

Finance function is the part of financial management. The finance function is expected to
assist the top management in formulation of strategic goal and achieve goals.
Controller

Treasurer
Financial
Planning

Cash
Management

Fund
Requisition

Investment
Decision

Investment
Decisions

Risk
Management

External
Reporting
Tax Planning
& Management
Management
Information System

Financial Management
and accounting
Budget Planning
and Controlling
Accounts
Receivable

The finance function of an international firm has two functions namely, treasury and
control. The treasurer is responsible for financial planning analysis, fund acquisition, investment
financing, cash management, investment decision and risk management. On the other hand,
controller deals with the functions related to external reporting, tax planning and management,
management information system, financial and management accounting, budget planning and
control, and accounts receivables etc.
For maximizing the returns from investment and to minimize the cost of finance, the firm
has to take portfolio decision based on analytical skills required for this purpose. Since the firm
has to raise funds from different financial markets of the world, which needs to actively exploit
market imperfections and the firms superior forecasting ability to generate purely financial
gains. The complex nature of managing international finance is due to the fact that a wide variety
of financial instruments, products, funding options and investment vehicles are available for both
reactive and proactive management of corporate finance.
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International finance is multidisciplinary in nature, while an understanding of economic

theories and principles is necessary to estimate and model financial decisions, financial
accounting and management accounting help in decision making in financial management at
multinational level.

INTERNATIONAL MONETARY SYSTEM

International monetary system is defined as a set of laws, rules, agreements, procedures,
mechanisms, processes, institutions to establish that rate at which exchange rate is determined in
respect to other currency.
The international monitory system plays a crucial role in the financial management of
multinational business and economic and financial policies of each country. To understand the
complex procedure of international trading practices, have a look at the history of the financial
and monetary system. Evolution of this can be analyzed in 4 stages:
1) The Gold Standard, 1876-1913:
The oldest system of exchange rate was known as "Gold Species Standard" in which
actual currency contained a fixed content of gold. The other version called "Gold Bullion
Standard", where the basis of money remained fixed gold but the authorities were ready to
convert, at a fixed rate, the paper currency issued by them into paper currency of another country
which is operating in Gold. The exchange rate between pair of two currencies was determined by
respective exchange rates against 'Gold' which was called 'Mint Parity'.
2) The inter war years, 1914-1944:
WWI ended the classical gold standard as major countries suspended redemption of
banknotes in gold and imposed ban on gold exports. The U.S has replaced Britain as the
dominant financial power. The major countries gave priority to stabilization of domestic
economies by matching inflows and outflows of gold with reductions and increase in domestic
money and credit.
3) The Bretton Woods System, 1945-1973:
After the war the world economy & monetary system, allied powers held a conference
in 'Bretton Woods', which gave birth to two super institutions - IMF and the WB. In Bretton
Woods modified form of Gold Exchange Standard was set up with the following characteristics:
One US dollar conversion rate was fixed by the USA as one dollar = 35 ounce of Gold

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Other members agreed to fix the parities of their currencies vis--vis dollar with respect
to permissible central parity with one per cent ( 1%) fluctuation on either side. In case
of crossing the limits, the authorities were free hand to intervene to bring back the
exchange rate within limits.
4) Flexible Exchange Rate Regime since 1973:
The flexible exchange rate regime that replaced the Bretton Woods system was ratified
by the Jamaica Agreement. Following a spectacular rise and fall of the US dollar in the 1980s,
major industrial countries agreed to cooperate to achieve greater exchange rate stability. It is a
system based purely on demand and supply for a currency in foreign exchange market.

FIXED AND FLOATING SYSTEM:

(a) Fixed Exchange Rate System:
A fixed exchange rate denotes a nominal exchange rate that is set firmly by the
monetary authority with respect to a foreign currency or a basket of foreign currencies.
Fixed exchange rate is the rate which is officially fixed by the government or monetary
authority and not determined by market forces. In this system, foreign central banks stand ready
to buy and sell their currencies at a fixed price.
Merits:
(i) It ensures stability in exchange rate which encourages foreign trade, (ii) It contributes to the
coordination of macro policies of countries in an interdependent world economy, (iii) Fixed
exchange rate ensures that major economic disturbances in the member countries do not occur,
(iv) It prevents capital outflow, (v) Fixed exchange rates are more conducive to expansion of
world trade because it prevents risk and uncertainty in transactions, (vi) It prevents speculation in
foreign exchange market.
Demerits:
(i) Fear of devaluation. In a situation of excess demand, central bank uses its reserves to maintain
foreign exchange rate. But when reserves are exhausted and excess demand still persists,
government is compelled to devalue domestic currency. If speculators believe that exchange rate
cannot be held for long, they buy foreign exchange in massive amount causing deficit in balance
of payment. This may lead to larger devaluation. This is the main flaw or demerit of fixed

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exchange rate system, (ii) Benefits of free markets are deprived; (iii) There is always possibility
of under-valuation or over-valuation.
b) Flexible (Floating) Exchange Rate System:
A floating exchange rate or fluctuating exchange rate is a type of exchange-rate regime
in which a currency's value is allowed to fluctuate according to the foreign-exchange market. A
currency that uses a floating exchange rate is known as a floating currency. The system of
exchange rate in which rate of exchange is determined by forces of demand and supply of
foreign exchange market is called Flexible Exchange Rate System.
There is no official intervention in foreign exchange market. Under this system, the
central bank, without intervention, allows the exchange rate to adjust so as to equate the supply
and demand for foreign currency. When market forces determine the rate, it is called floating
exchange rate
Merits:
(i) Deficit or surplus in BOP is automatically corrected, (ii) There is no need for government to
hold any foreign exchange reserve, (iii) It helps in optimum resource allocation, (iv) It frees the
government from problem of BOP
Demerits:
(i) It encourages speculation leading to fluctuations in foreign exchange rate, (ii) Wide
fluctuation in exchange rate hampers foreign trade and capital movement between countries, (iii)
It generates inflationary pressure when prices of imports go up due to depreciation of currency.

Distinction between Fixed Exchange Rate and Flexible Exchange Rate:

Fixed exchange rate is the rate which is officially fixed in terms of gold or any other
currency by the government. It does not change with change in demand and supply of foreign
currency. As against it, flexible exchange rate is the rate which, like price of a commodity, is
determined by forces of demand and supply in the foreign exchange market. It changes
according to change in demand and supply of foreign currency. There is no government
intervention.