Global Business Finance

Chapter - 1 International Financial Management

Meaning: International Financial Management is a well-known term in today s world and it is also known as international finance. It means financial management in an international level business environment. It is different because of different currency of different countries, dissimilar political situations, imperfect markets, diversified opportunity sets. However international financial management is concerned with management of international related financial functions . In other words, International financial management is a branch of general management which is mainly concerned with acquisition of funds and investment of fund in the area of international business and it also facilitate to manage the finance effectively with the help of financial instrument in order to increase the wealth of the shareholders. Modes of entry into an International Business: There are some basic decisions that the firm must take before foreign expansion like: which markets to enter, when to enter those markets, and on what scale. Which foreign markets? -The choice based on nation s long run profit potential. -Look in detail at economic and political factors which influence foreign markets. -Long run benefits of doing business in a country depend on following factors: - Size of market (in terms of demographics) - The present wealth of consumer markets (purchasing power) - Nature of competition By considering such factors firm can rank countries in terms of their attractiveness and long-run profit. Timing of entry: It is important to consider the timing of entry. Entry is early when an international business enters a foreign market before other foreign firms. And late when it enters after other international businesses. The advantage is when firms enters early in the foreign market commonly known as first-mover advantages First mover advantage: a. It is the ability to prevent rivals and capture demand by establishing a strong brand name. b. Ability to build sales volume in that country. So that they can drive them out of market. c. Ability to create customer relationship. Disadvantage: a. Firm has to devote effort, time and expense to learning the rules of the country. b. Risk is high for business failure(probability increases if business enters a national market after several other firms they can learn from other early firms mistakes) Modes of entry:

1. 2. 3. 4. 5. 6. 7. 8.

Exporting Licensing Franchising Turnkey Project Mergers & Acquisitions: Joint Venture Acquisitions & Mergers Wholly Owned Subsidiary

1. Exporting: It means the sale abroad of an item produced, stored or processed in the supplying firm s home country. It is a convenient method to increase the sales. Passive exporting occurs when a firm receives canvassed them. Active exporting conversely results from a strategic decision to establish proper systems for organizing the export functions and for procuring foreign sales. Advantages of Exporting: a. Need for limited finance: If the company selects a company in the host country to distribute the company can enter international market with no or less financial resources but this amount would be quite less compared to that would be necessary under other modes. b. Less Risk: Exporting involves less risk as the company understands the culture, customer and the market of the host country gradually. Later after understanding the host country the company can enter on a full scale. c. Motivation for exporting: Motivation for exporting are proactive and reactive. Proactive motivations are opportunities available in the host country. Reactive motivators are those efforts taken by the company to export the product to a foreign country due to the decline in demand for its product in the home country. 2. Licensing: In this mode of entry, the domestic manufacturer leases the right to use its intellectual property (i.e.) technology, copy rights, brand name etc. to a manufacturer in a foreign country for a fee. Here the manufacturer in the domestic country is called licensor and the manufacturer in the foreign is called licensee. The cost of entering market through this mode is less costly. The domestic company can choose any international location and enjoy the advantages without incurring any obligations and responsibilities of ownership, managerial, investment etc. Advantages of Licensing: a. b. c. d. e. Low investment on the part of licensor. Low financial risk to the licensor Licensor can investigate the foreign market without much effort on his part. Licensee gets the benefits with less investment on research and development. Licensee escapes himself from the risk of product failure.

Disadvantages of Licensing: a. It reduces market opportunities for both. b. Both parties have to maintain the product quality and promote the product. Therefore one party can affect the other through their improper acts. c. Chance for misunderstanding between the parties. d. Chance for leakages of the trade secrets of the licensor. e. Licensee may develop his reputation f. Licensee may sell the product outside the agreed territory and after the expiry of the contract. 3. Franchising: Under franchising an independent organization called the franchisee operates the business under the name of another company called the franchisor under this agreement the franchisee pays a fee to the franchisor. The franchisor provides the following services to the franchisee. a. b. c. d. Trade marks Operating System Product reputation Continuous support system like advertising, employee training, and reservation services quality assurances program etc.

Advantages of Franchising: a. Low investment and low risk b. Franchisor can get the information regarding the market culture, customs and environment of the host country. c. Franchisor learns more from the experience of the franchisees. d. Franchisee gets the benefits of R& D with low cost. e. Franchisee escapes from the risk of product failure. Disadvantages of Franchising: a. It may be more complicating than domestic franchising. b. It is difficult to control the international franchisee. c. It reduces the market opportunities for both. Both the parties have the responsibilities to maintain product quality and product promotion. d. There is a problem of leakage of trade secrets. 4. Turnkey Project: A turnkey project is a contract under which a firm agrees to fully design, construct and equip a manufacturing/ business/services facility and turn the project over to the purchase when it is ready for operation for

remuneration like a fixed price, payment on cost plus basis. This form of pricing allows the company to shift the risk of inflation enhanced costs to the purchaser. E.g. nuclear power plants, airports, oil refinery, national highways, railway line etc. Hence they are multiyear project. 5. Mergers & Acquisitions: A domestic company selects a foreign company and merger itself with foreign company in order to enter international business. Alternatively the domestic company may purchase the foreign company and acquires it ownership and control. It provides immediate access to international manufacturing facilities and marketing network. Advantages of Mergers & Acquisitions: a. The company immediately gets the ownership and control over the acquired firm s factories, employee, technology, brand name and distribution networks. b. The company can formulate international strategy and generate more revenues. c. If the industry already reached the stage of optimum capacity level or overcapacity level in the host country. This strategy helps the host country. Disadvantages of Mergers & Acquisitions: a. Acquiring a firm in a foreign country is a complex task involving bankers, lawyers regulation, mergers and acquisition specialists from the two countries. b. This strategy adds no capacity to the industry. c. Sometimes host countries imposed restrictions on acquisition of local companies by the foreign companies. d. Labor problem of the host country s companies are also transferred to the acquired company. 6. Joint Venture: Two or more firm join together to create a new business entity that is legally separate and distinct from its parents. It involves shared ownership. Various environmental factors like social, technological economic and political encourage the formation of joint ventures. It provides strength in terms of required capital. Latest technology required human talent etc. and enable the companies to share the risk in the foreign markets. This act improves the local image in the host country and also satisfies the governmental joint venture. Advantages of Joint Venture: a. b. c. d. e. Joint venture provides large capital funds suitable for major projects. It spread the risk between or among partners. It provides skills like technical skills, technology, human skills, expertise, and marketing skills. It makes large projects and turn key projects feasible and possible. It synergy due to combined efforts of varied parties.

Disadvantages of Joint Venture: a. Conflict may arise among partners.

b. Partner delay the decision making once the dispute arises. Then the operations become unresponsive and inefficient. c. Life cycle of a joint venture is hindered by many causes of collapse. d. Scope for collapse of a joint venture is more due to entry of competitor s changes in the partners strength. e. The decision making is slowed down in joint ventures due to the involvement of a number of parties. 7. Acquisitions & Mergers: A merger is a voluntary and permanent combination of business whereby one or more firms integrate their operations and identities with those of another and henceforth work under a common name and in the interests of the newly formed amalgamations. Motives for acquisitions: a. Removal of competitor b. Reduction of the Co failure through spreading risk over a wider range of activities. c. The desire to acquire business already trading in certain markets & possessing certain specialist employees & equipment s. d. Obtaining patents, license & intellectual property. e. Economies of scale possibly made through more extensive operations. f. Acquisition of land, building & other fixed asset that can be profitably sold off. g. The ability to control supplies of raw materials. h. Expert use of resources. i. Tax consideration. j. Desire to become involved with new technologies & management method particularly in high risk industries.

8. Wholly Owned Subsidiary: A wholly-owned subsidiary is a company whose stock is entirely owned by another company. The owner of a wholly-owned subsidiary is known as the parent company or holding company. Because the parent company owns all of the stock of the wholly-owned subsidiary, the parent company can control all of its activities. Foreign Direct Investment: An investment abroad, usually where the company being invested in is controlled by the foreign corporation. Direct investment in productive assets by a company incorporated in foreign country, as opposed to direct investment in a particular sector like banking, insurance, shares of local companies by foreign entities is known as Foreign Direct Investment. Foreign Institutional Investment: Foreign Institutional investors are organizations which pool large sums of money and invest those sums in securities, real property and other investment assets. They can also include operating companies which decide to invest their profits to some degree in these types of assets.

Types of typical investors include banks, insurance companies, retirement or pension funds, hedge funds, investment advisors and mutual funds. Their role in the economy is to act as highly specialized investors on behalf of others. Meaning of International finance: International financial management refers to the financial functions of an overseas business. International finance is the branch of economics that studies the dynamics of exchange rates, foreign investment, global financial system, and how these affect international trade. It also studies international projects, international investments and capital flows, and trade deficits. It includes the study of futures, options and currency swaps. International business means carrying out business activity behind national boundary, these activities includes normally international trade of goods and services and also international production of goods and provision of services.

Functions and scope of IFM: 1. Foreign exchange market: It is a market where short & long term securities or foreign currencies are bought and sold. It is open for trading 24 hours a day. Exchange rate determination: An exchange rate between two currencies is the rate at which one currency will be exchanged for another. It is also regarded as the value of one countrys currency in terms of another currency. Appreciation or depreciation rate for one currency in terms of another country currency. Exchange risk and management: Value of one country currency is differs from another country, so there is a risk in appreciation & depreciation of value of currency. Investment decision in MNC s: Total assets held by firm it may be long term assets or short term assets. International Financial Market: It is a market at finance is available like, export & import bank, World Bank & Asian development bank. Financing decision: Equity also dangerous & debentures also dangerous. MNC s working capital management: Since MNC s have operations in different countries, the financial transactions will also be denominated in multiple currencies. Hence, financial management of short-term assets and liabilities in an MNC is much more important and complex in nature. IT involves management of current assets and current liabilities denominated in different currencies. International taxation and accounting strategy: Parent company is going to prepare a consolidated balance sheet based on taxation & accounting strategy. Balance of payment:

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Every government has to prepare the balance of payment for knowing financial position. India is deficit position due to lower the export & higher the export. Foreign Exchange Market: It is a place where money denominated in one currency is bought and sold money denominated with other currency. In facilitates conversion of currency & provides credit for international transaction. EG., US firm s imports goods from a British company, US dollars need to be converted in bonds. This conversion from one currency to another typical form of transaction that takes place in foreign exchange market. Exchange Rate Determination: It is a price for foreign currency express in terms of local currency, its determination and forecasting along with factors influencing exchange rate. Investment Decision: It involves the determination of total amount of assets to held by the firms. Financial managers must quantify the benefits, cost & risk associated with an investment in a foreign country. Factors responsible for IFM:             Globalization Growth in International trade Growth in Foreign investment Structural changes in international financial market Adoption of floating exchange rate regime Fast development in information technology Political condition Foreign exchange risk management Inflation rate Competition Market imperfection Tax planning

Objectives of IFM:       Profit maximization Wealth maximization Ensure fair return on investments Minimization of political risk & exchange risk Effective utilization of available funds Effective management of Inflation risk

Global Financial Manager:

He is a person who is mainly responsible to perform all the financial functions as related to international business is called Global financial manager. Roles of Global Financial Manager: 1. Financial planning:  How to make the product?  Where the raw material does comes from?  Where the fund does comes from? Forecasting the financial environment:  Price  Interest rate  Inflation  Exchange rate  Government policy Making investment decision Making financial decision International cash management:  Minimizing cash balances  Minimizing currency conversion cost Foreign exchange risk management Controlling the uses of funds Disposition of profits Maintain liquidity & wealth International taxation Analyze balance of payments if deficit, heavy inflation Difference between IFM and DFM Concept Culture & History Corporate Governance Foreign Exchange Risk Political Risk Modification of Domestic Financial Theories Modified Domestic Instrument IFM Each foreign country is unique & not always understood by MNC s Foreign country regulation & institutional product are all uniquely different MNC s face foreign exchange risk due to their subsidiaries as well as Import & Export Because of their foreign subsidiaries Must modify finance theories DFM Each country has a known base case Regulators & Institutions are well known Foreign Exchange Risk from Import & Export & foreign competition Aware of political condition & negligible political risk Traditional theories apply

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6. 7. 8. 9. 10. 11.

MNC s utilize modified financial instrument. Ex., Options, Futures, Swaps, ADR, GDR, ECB etc.

Entry limited instruments are used. Ex., Equity, Preference, Debenture

Chapter - 2 Foreign Exchange Market

Meaning: The market in which participants are able to buy, sell, exchange and speculate on currencies. Foreign exchange markets are made up of banks, commercial companies, central banks, investment management firms, hedge funds, and retail forex brokers and investors. The forex market is considered to be the largest financial market in the world. Because the currency markets are large and liquid, they are believed to be the most efficient financial markets. It is important to realize that the foreign exchange market is not a single exchange, but is constructed of a global network of computers that connects participants from all parts of the world. Foreign exchange market is a place where foreign exchange is bought and sold. Foreign exchanges is thesystem or process of converting one national currency into another. Foreign exchange market management transactions a party purxhases a quantity of one currency by paying a quantity of another currency. Featurees of Foreign Exchange Market: