UNIT-1

Introduction to International Financial Management: Concept, Theories, Contents

International financial management is the study of financial transactions between individuals, companies,
and governments in different countries. It involves managing financial risks, capital flows, and currency
exchange rates across national borders. The primary objective of international financial management is to
maximize profits by minimizing risks in the global business environment.

There are various theories associated with international financial management, including the theory of
comparative advantage, the purchasing power parity theory, and the interest rate parity theory. The theory
of comparative advantage argues that countries should specialize in the production of goods and services
that they can produce efficiently and cost-effectively, while importing goods and services that are
produced more efficiently by other countries. The purchasing power parity theory argues that exchange
rates between currencies should adjust to reflect the price differences between goods and services in
different countries. The interest rate parity theory argues that the difference in interest rates between two
countries should equal the expected change in exchange rates between those countries.

The contents of international financial management include foreign exchange risk management,
international investment analysis, and international trade financing. Foreign exchange risk management
involves identifying and managing the risks associated with currency exchange rate fluctuations.
International investment analysis involves evaluating investment opportunities in different countries,
including political and economic risks. International trade financing involves arranging financing for
international trade transactions, including trade credit and export financing.

Recent Trends and Challenges in International Finance

Recent trends in international finance include the growth of emerging markets, the increasing role of
technology, and the rise of sustainable finance. Emerging markets, such as China and India, have
experienced rapid economic growth in recent years, leading to increased foreign investment and trade
opportunities. Technology has also played a significant role in international finance, with the rise of
fintech and blockchain technology enabling faster, cheaper, and more secure financial transactions.
Sustainable finance, which focuses on investments that have positive environmental, social, and
governance (ESG) impacts, has also become increasingly popular in recent years.

However, international finance also faces several challenges, including geopolitical risks, currency
fluctuations, and regulatory changes. Geopolitical risks, such as trade tensions between the United States
and China or political instability in the Middle East, can have a significant impact on international
finance. Currency fluctuations can also cause significant losses or gains for companies and investors
engaged in international transactions. Regulatory changes, such as changes in tax laws or financial
regulations, can also create uncertainty and increase compliance costs for international businesses.

International Monetary System: Concept, Evolution of International Monetary System, Different

Exchange Rate Regimes, International Monetary Fund and Risk, Exchange Rate Mechanism

The international monetary system refers to the institutional framework and rules governing international
monetary transactions, including currency exchange rates and the allocation of international reserves. The
evolution of the international monetary system can be divided into several phases, including the gold
standard era, the Bretton Woods era, and the post-Bretton Woods era.

The gold standard era, which lasted from the late 19th century to the early 20th century, was characterized
by a fixed exchange rate system in which currencies were pegged to gold. The Bretton Woods era, which
lasted from 1944 to 1971, was characterized by a fixed exchange rate system in which currencies were
pegged to the US dollar, which was in turn pegged to gold. The post-Bretton Woods era, which began in
the 1970s and continues to the present day, is characterized by a floating exchange rate system in which
exchange rates are determined by market forces.

There are several exchange rate regimes, including fixed exchange rates, flexible exchange rates, and
managed exchange rates. Fixed exchange rates are set by governments and do not change based on
market forces. Flexible exchange rates are determined by market forces and can fluctuate freely. Managed
exchange rates are a combination of fixed

UNIT-2

International Investment Strategies: FDI and Portfolio Investment

International investment strategies are used by companies and investors to invest in foreign markets. The
two primary international investment strategies are foreign direct investment (FDI) and portfolio
investment.

• FDI refers to the investment made by a company in a foreign country by establishing a subsidiary
or acquiring a controlling stake in an existing company. FDI is a long-term investment strategy
that allows companies to gain access to new markets, resources, and technologies.

Example: Toyota Motor Corporation's investment in the United States is an example of FDI. Toyota has
established manufacturing plants in several U.S. states and employs thousands of U.S. workers.

• Portfolio investment refers to the purchase of securities, such as stocks and bonds, in foreign
markets. Portfolio investment is a short-term investment strategy that allows investors to diversify
their investment portfolios and potentially earn higher returns.
Example: An investor from Japan purchasing shares of a technology company listed on the New York
Stock Exchange is an example of portfolio investment.

International Financing Sources and Cost of Foreign Borrowings

Companies engaged in international business require financing to support their operations. The sources of
international financing include:

• Equity financing: Issuing shares of stock to investors in exchange for capital.

• Debt financing: Borrowing money from lenders and repaying the loan with interest.

• Export financing: Financing provided to companies engaged in international trade to facilitate the
sale of goods and services.

The cost of foreign borrowings depends on several factors, including:

• Interest rates: The cost of borrowing money is influenced by the prevailing interest rates in the
country where the loan is obtained.

• Exchange rates: The cost of borrowing money denominated in a foreign currency is influenced by
the exchange rate between the borrower's currency and the currency in which the loan is
denominated.

Example: A U.S. company borrowing Japanese yen to finance a business venture in Japan will be subject
to the prevailing interest rate in Japan and the exchange rate between the U.S. dollar and the Japanese
yen.

Cross Currency Management

Cross-currency management involves managing the risks associated with foreign currency transactions.
The two primary risks associated with cross-currency management are:

• Transaction risk: The risk of losses arising from fluctuations in exchange rates between the time a
transaction is initiated and the time it is settled.

• Translation risk: The risk of losses arising from fluctuations in exchange rates when a company's
financial statements are translated into a different currency.

Companies can manage cross-currency risks through several strategies, including:

• Hedging: Entering into financial contracts, such as forward contracts or options contracts, to lock
in exchange rates and reduce the risk of losses.

• Netting: Consolidating foreign currency transactions to reduce the overall exposure to exchange
rate fluctuations.

• Matching: Matching foreign currency cash inflows with outflows to reduce the need for foreign
currency transactions.

Example: A U.S. company purchasing goods from a Japanese supplier can hedge its transaction risk by
entering into a forward contract to lock in the exchange rate between the U.S. dollar and the Japanese yen
at the time of the transaction.
 UNIT-3

Balance of Payments: Concept, Items, Types of Transactions, Types of Accounts, and Significance of
BOPs

The balance of payments (BOP) is a statement that summarizes all the economic transactions between a
country and the rest of the world over a specific period. The BOP is a critical tool for analyzing a
country's international economic transactions and its financial position with the rest of the world.

The BOP consists of two main accounts:

• Current account: Records all the transactions that involve the export and import of goods and
services, income flows, and current transfers between a country and the rest of the world.

• Capital account: Records all the transactions that involve the purchase and sale of assets,
including both financial and non-financial assets, between a country and the rest of the world.

The BOP is composed of several items, including:

• Merchandise trade: Records the export and import of goods.

• Services trade: Records the export and import of services, such as tourism, banking, and
insurance.

• Income flows: Records the income earned by residents of a country from their investments abroad
and the income earned by foreigners from their investments in a country.

• Current transfers: Records the transfer of funds between a country and the rest of the world, such
as foreign aid and remittances.

The BOP has several types of transactions, including:

• Visible transactions: Transactions that involve the exchange of tangible goods, such as cars,
machinery, and agricultural products.

• Invisible transactions: Transactions that involve the exchange of intangible goods and services,
such as tourism, banking, and insurance.

The BOP has two types of accounts:

• Official BOP: Records the transactions between a country and the rest of the world that are
conducted by the government.

• Private BOP: Records the transactions between a country and the rest of the world that are
conducted by private individuals and businesses.

The BOP is significant for several reasons, including:

• It provides insight into a country's economic relationships with other countries and its financial
position with the rest of the world.

• It helps policymakers to identify the sources of imbalances in the economy, such as trade deficits,
and to develop policies to correct these imbalances.
 • It helps investors to make informed investment decisions by providing information about a
country's economic prospects.

Disequilibrium in BOPs: Its Types, Current Account Deficit, and Its Implications

Disequilibrium in BOPs refers to a situation where a country's international transactions are not in
balance, resulting in a surplus or deficit in the BOP. There are two types of disequilibrium in the BOP:

• Surplus: A situation where a country's export earnings exceed its import payments, resulting in a
positive BOP.

• Deficit: A situation where a country's import payments exceed its export earnings, resulting in a
negative BOP.

A current account deficit occurs when a country's imports exceed its exports in the current account. A
current account deficit can have several implications, including:

• It can lead to a depletion of foreign exchange reserves.

• It can lead to a depreciation in the value of the currency.

• It can increase the cost of borrowing from foreign lenders.

• It can lead to inflationary pressures in the economy.

Remedial Measures for Correcting Disequilibrium in BOPs

Several remedial measures can be taken to correct disequilibrium in the BOP, including:

• Fiscal policy: The government can reduce its expenditure or increase its revenue to reduce the
demand for imports.

• Monetary policy: The central bank can increase interest rates to reduce the demand for imports.

• Exchange rate policy: The government can devalue its currency to make its exports more
competitive and reduce the demand for imports.

• Structural policy: The government can implement structural reforms to improve the
competitiveness of the economy, such as improving the education system or investing in
infrastructure.

• Export promotion: The government can provide incentives to exporters to increase their exports.

• Import substitution: The government can encourage the production of goods that are currently
imported to reduce the demand for imports.

International Payments Gateway Exchange Risk Management – Hedging

• International payments gateway exchange risk management involves managing the risk of
fluctuations in exchange rates when making international payments. Hedging is a common
strategy used to manage exchange rate risk. Hedging involves taking a position in the foreign
 exchange market that is equal and opposite to the exposure to the foreign currency. This helps to
reduce the impact of fluctuations in exchange rates on the value of the transaction.

• There are several hedging techniques available, including:

• Forward contracts: A forward contract is an agreement to buy or sell a currency at a

predetermined rate on a future date.

• Options: An option is a contract that gives the holder the right, but not the obligation, to buy or
sell a currency at a predetermined rate on a future date.

• Futures contracts: A futures contract is similar to a forward contract, but it is traded on an

exchange.

• Swaps: A swap involves exchanging one currency for another at the current spot rate and then
exchanging them back at a predetermined rate on a future date.

• Hedging can help businesses to reduce their exposure to exchange rate risk and to better manage
their cash flows. However, hedging can also be costly, and there is a risk that the hedging strategy
may not be effective in mitigating the impact of exchange rate fluctuations.

• In conclusion, international financial management is a complex field that involves managing a

range of risks and uncertainties associated with international economic transactions.
Understanding the concepts and theories of international financial management is essential for
businesses, policymakers, and investors to make informed decisions in the global economy.

UNIT-4

Foreign Exchange Rate: Meaning, types and determinants of foreign exchange rate

Foreign exchange rate refers to the rate at which one currency can be exchanged for another
currency. The value of a currency is determined by the forces of supply and demand in the foreign
exchange market. There are several types of exchange rates, including:

• Nominal exchange rate: The nominal exchange rate is the rate at which one currency can be
exchanged for another currency.

• Real exchange rate: The real exchange rate is the rate at which the goods and services of one
country can be exchanged for the goods and services of another country. It takes into account the
relative prices of goods and services in the two countries.

• Effective exchange rate: The effective exchange rate is a weighted average of the exchange rates
of a currency against a basket of other currencies. It reflects the competitiveness of a country's
exports in the global market.

The determinants of foreign exchange rates include:

• Economic fundamentals: The economic fundamentals of a country, such as inflation, interest

rates, and economic growth, can influence the demand for its currency.

• Political factors: Political instability or changes in government policies can affect the value of a
currency.
• Market sentiment: Market sentiment can also influence foreign exchange rates. If investors have a
positive outlook on a country's economy, they may demand more of its currency, leading to an
increase in its value.

Spot market and Forward Market

The spot market is the market where currencies are bought and sold for immediate delivery. In the
spot market, the exchange rate is determined by the forces of supply and demand in real-time.

The forward market is the market where currencies are bought and sold for future delivery. In the
forward market, the exchange rate is agreed upon at the time of the transaction but the actual
exchange of currencies takes place at a later date. This allows businesses to lock in an exchange
rate for a future transaction to mitigate the risk of fluctuations in exchange rates.

The Real Exchange Rate, Real Effective Exchange Rate (REER) and Cross Rates

The real exchange rate is the rate at which the goods and services of one country can be
exchanged for the goods and services of another country, taking into account the relative prices of
goods and services in the two countries. It is calculated as the nominal exchange rate multiplied
by the ratio of the price level of a basket of goods and services in one country to the price level of
the same basket of goods and services in another country.

The real effective exchange rate (REER) is a weighted average of the real exchange rates of a
currency against a basket of other currencies. It reflects the competitiveness of a country's exports
in the global market.

Cross rates refer to the exchange rate between two currencies, neither of which is the currency of
the country in which the quote is given. For example, the cross rate between the euro and the
Japanese yen would be the exchange rate between the euro and the US dollar, multiplied by the
exchange rate between the US dollar and the Japanese yen.

Foreign Exchange Rate Forecasting and Currency Derivatives

Foreign exchange rate forecasting involves predicting future exchange rates based on past trends
and current economic conditions. This can be done using a variety of methods, including
technical analysis and fundamental analysis.

Currency derivatives are financial instruments that are used to manage the risk of fluctuations in
exchange rates. They include:

• Forward contracts: A forward contract is an agreement to buy or sell a currency at a

predetermined rate on a future date.

• Options: An option is a contract that gives the holder the right, but not the obligation, to buy or
sell a currency at a predetermined rate on a future date.

• Futures contracts: A futures contract is similar to a forward contract, but it is traded on an

exchange.

• Swaps: A swap involves exchanging one currency for another at the current
 UNIT-5

Exchange Rate Determination:

Exchange rate determination refers to the process of determining the value of one currency in
relation to another currency. In other words, it is the process by which the price of one currency is
determined in terms of another currency. There are various theories that explain how exchange
rates are determined in the foreign exchange market.

1. The Purchasing Power Parity (PPP) Theory:

The purchasing power parity theory is one of the most widely used theories to determine the
exchange rate between two currencies. This theory is based on the law of one price, which states
that identical goods should have the same price in different countries after adjusting for the
exchange rate. According to this theory, the exchange rate between two currencies should be
equal to the ratio of the price levels of the two countries.

For example, if the price of a basket of goods in the United States is $100, and the price of the
same basket of goods in Japan is ¥10,000, then the exchange rate between the US dollar and the
Japanese yen should be 1 US dollar = 100 Japanese yen. However, in reality, exchange rates do
not always follow the PPP theory due to various factors such as trade barriers, transportation
costs, and taxes.

2. The Absolute Form and the Relative Form:

The PPP theory can be expressed in two forms: the absolute form and the relative form. The
absolute form of the PPP theory states that the exchange rate between two currencies should be
equal to the ratio of the price levels of the two countries. The relative form of the PPP theory
states that the change in the exchange rate between two currencies should be equal to the
difference in the inflation rates of the two countries.

For example, if the inflation rate in the United States is 2% and the inflation rate in Japan is 1%,
then the exchange rate between the US dollar and the Japanese yen should appreciate by 1% to
maintain the purchasing power parity between the two currencies.
3. Interest Rate Parity Theory:

The interest rate parity theory is another theory that explains how exchange rates are determined
in the foreign exchange market. According to this theory, the exchange rate between two
currencies should be equal to the ratio of the interest rates of the two countries. This theory is
based on the assumption that investors are rational and seek to maximize their returns by
investing in the country with higher interest rates.

For example, if the interest rate in the United States is 2% and the interest rate in Japan is 1%,
then the exchange rate between the US dollar and the Japanese yen should appreciate by 1% to
equalize the returns from investing in the two currencies.

4. The Balance of Payments Theory:

The balance of payments theory is another theory that explains how exchange rates are
determined in the foreign exchange market. According to this theory, the exchange rate between
two currencies is determined by the balance of payments of the two countries. The balance of
payments is a record of all the transactions between a country and the rest of the world, including
trade, investment, and remittances.

For example, if a country has a trade surplus, meaning it exports more than it imports, then there
will be a demand for its currency in the foreign exchange market, which will lead to an
appreciation of its currency. On the other hand, if a country has a trade deficit, meaning it imports
more than it exports, then there will be a supply of its currency in the foreign exchange market,
which will lead to a depreciation of its currency.

In conclusion, there are various theories that explain how exchange rates are determined in the
foreign exchange market. The PPP theory, interest rate parity theory, and balance of payments
theory are some of the most widely used theories. However, in reality, exchange rates are
determined by a complex set of factors, including economic fundamentals, market sentiment.

UNIT-6

Global Financial Markets: Recent Developments and Challenges

Global financial markets refer to the interconnected networks of markets where securities,
currencies, commodities, and other financial instruments are traded. These markets have
undergone significant changes and faced numerous challenges in recent years.
1. Recent Developments:

a. Technological Advances: One of the biggest recent developments in global financial markets is
the rapid advancement of technology. The rise of electronic trading platforms, algorithmic
trading, and artificial intelligence has transformed the way financial markets operate.

b. Rise of Emerging Markets: Emerging markets such as China, India, and Brazil have become
major players in global financial markets in recent years. These markets have seen significant
growth in their economies and financial systems, leading to increased investment and trading
activity.

c. Regulatory Changes: Following the global financial crisis of 2008, there have been significant
regulatory changes aimed at increasing transparency, reducing risk, and improving the stability of
financial markets. Examples of such regulations include the Dodd-Frank Act in the United States
and Basel III in the European Union.

2. Challenges:

a. Geopolitical Risks: The global financial markets are highly sensitive to geopolitical risks such
as political instability, trade disputes, and military conflicts. These risks can lead to increased
volatility and uncertainty in financial markets.

b. Cybersecurity Threats: With the increasing use of technology in financial markets, there is a
growing risk of cybersecurity threats such as hacking and data breaches. These threats can have
significant consequences for financial institutions and their customers.

c. Low Interest Rates: Many countries have implemented low-interest-rate policies in response to
the global financial crisis of 2008. While these policies have helped to stimulate economic
growth, they have also created challenges for investors seeking to generate returns in a low-
interest-rate environment.

In conclusion, global financial markets have undergone significant changes and faced numerous
challenges in recent years. While technological advances and the rise of emerging markets have
created new opportunities, geopolitical risks, cybersecurity threats, and low-interest rates remain
major challenges.

Global Foreign Exchange Markets: Characteristics & Recent Trends

Global foreign exchange (forex) markets refer to the decentralized markets where currencies are
traded. Forex markets are the largest financial markets in the world, with an average daily trading
volume of over $6 trillion.

1. Characteristics:

a. Decentralized: Forex markets are decentralized, meaning there is no central exchange where all
trades take place. Instead, forex trading is conducted electronically over a network of banks and
financial institutions.

b. High Liquidity: Forex markets are highly liquid, meaning that there is a high volume of trading
activity, and traders can easily buy and sell currencies without affecting their prices significantly.

c. High Volatility: Forex markets are highly volatile, meaning that currency prices can fluctuate
rapidly in response to economic, political, and other factors.

2. Recent Trends:

a. Increased Electronic Trading: Electronic trading platforms have become increasingly popular in
forex markets, allowing traders to access liquidity and execute trades quickly and efficiently.

b. Growing Role of Emerging Markets: Emerging markets such as China, India, and Brazil have
become significant players in forex markets in recent years. These markets have seen increased
trading activity as their currencies have become more widely traded.

c. Use of Artificial Intelligence: Artificial intelligence (AI) is increasingly being used in forex
trading to analyze market data and make trading decisions. AI can help traders to identify trading
opportunities and manage risk more effectively.
In conclusion, global forex markets are highly decentralized, liquid, and volatile. Recent trends in
forex markets include the increased use of electronic trading platforms, the growing role of
emerging markets, and the use of artificial intelligence in trading.