INTERNATIONAL FINANCE

International financial management is a well-known term in today’s word and it

is also known as international finance. It means financial management in an
international business environment.
International finance is the branch of economics that studies the dynamics of
exchange rates, foreign investments, and how these affect international trade.
Fundamentals of International Finance deal withthestudy of foreign investments,
the changes in the foreign exchange rates, and how international trade is influenced
by them. International finance also follows techniques for allocation of funds and
resource in international trade. However, it faces certain hindrances regarding
mobility of capital and foreign currencies, as well as the foreign also tries to solve the
problem of human resource exploitation carried out by MNC in the poor and
developing countries by applying its own principles, three conceptually distinct but
interrelated parts are identifiable in international finance.
International Financial Markets: Concerned With International Financial/
Investments Instruments, Foreign Exchange Markets, International Banking,
International Securities Markets Financial Derivatives Etc.
Expanded Opportunity To Business:- due to globalization in business there is an
expanded opportunity to the business. Business can raise more funds through less
cost of capital.
Foreign Exchange Risk: - It Is Financial Risk That Exists When A Financial
Transaction Is Denominates In A Currency Other Than That Of The Base Currency
Of The Company.
Imperfect Market:- Due to difference in law and customs among the countries,
tax system, cultural difference, business practices, there is distinction between
international business practices, there is distinction between international business
practice, there is distinction between international business practices, there is
distinction between international finance and domestic finance. so, it is said that there
is always an imperfect market. due to imperfection in market.
Political Risk:- International Financial System Affected By Government Policies
And Political Issues. So There Is A Risk Of Political Policies, International Finance
Can Be Affected. Similarly A Favorable Political Decision Can Increase International
Financial Stability.
Currently, International Finance Has Become More Comprehensive Pr Broader
In Scope And Is Dealing With Matters Related To Globalization, Fair Trade
Multinational Banking, And Multinational Corporation. International Finance Consist
Of Foreign Exchange Market, Currency Convertibility, BOP, International Finance
And International Monetary System.
International Finance Plays A Critical Role In International Trade And Inter-
Economy Exchange Of Goods And Services. It Is Important For A Number Of
Reasons; The Most Notable Ones Are Listed Here:
International finance helps keep international issues in a disciplined state.
International finance is an important tool to find the exchange rates, compare
inflation rates, get an idea about investing in international debt securities, ascertain
the economic status of other countries and judge the foreign markets.
International finance helps in calculating exchange rates which are very
important in international finance, as they let us determine the relative values of
currencies.
Various economic factors help in making international investments decisions.
Economic factors of economics help in determining whether or not investors money
is safe with foreign debt securities.
Utilizing IFRS is an import factor for any stages of international finance.
financial factor for many stages of international finance . financial statements made
by the countries that have adopted ifrs are similar. it helps many countries to follow
similar reporting systems.
IRFS system’ which is a part of international finance’ also helps in saving
money by following the rules of reporting on a single accounting standard.
 International Finance Has Grown In Nature Due To Globalization. It Helps
Understand The Basic Of All International Organization And Keeps The Balance
Intact Among Them.
An International Finance System Maintains Peace Among The Nations. Without
A Solid Finance Measures, All Nations Would Work For Their Self-Interest.
International Finance Helps In Keeping That Issue At Bay.
PRINCIPLES OF INTERNATIONAL FINANCE:
Advantages To Become International:- The Internationalization Advantages
Attract Companies To Invest Directly In Foreign Countries.
Comparative Merits:- Every Country Is Specialized In Some Product Of Has
Some Product Of Has Some Special Feature. Through International Trade Exchange
Of Verity Of Goods, Culture And Services Takes Place Through Trade. It Increases
The Standard Of Living.
Economic Of Scale: Synergistic Effect Direct To Economies of Scale. When
The Whole Is More Profitable Than The Part Of It Than Synergistic Effect Exists.
Effect Of Portfolio: As Per The Principles Of Portfolio It Is Said That The Risk
Is Diverted By Increasing The Portfolio. In Same Way The Company Can Diversify
Its Risk By Working On Global Level Rather Than Restricting In Domestic Level.
PerfectCompletion: - International Trade Allows Every Country to Entry In The
Market And Exist From The Market Freely. Under This Condition Goods And
Services Are Freely Transferable. So, the Balance of Cost no Return Exists.
Risk And Profitability Trade Off:- It Is Well Known That There Is A Close
Relation Between Risk And Profitability. But The Trade-Off Between Risk And
Profitability Decides The Maximization Balance Between Risk And Profitability.
Valuation Of Assets: - This Principle Says That The Value Of An Asset Is The
Expected Earning Of The Asset. For MNC’s Better Marketability, Earning More
Profit, Capitalization At Lower Rate Comparing To Domestic Companies Leads To
Higher Price Earnings Ratio And Lower Required Rate Of Return. So, The Value Of
MNC Is More Than The Domestic Companies.
 ADVANTAGES OF INTERNATIONAL FINANCE:
Promotion:- International Finance Helps To Promote Domestic Investments And
Growth Through Capital Market.
Better Banking System:- International Finance Helps To Healthy Competition
Due To Which It Provides Better Banking System.
More Equality:- It Helps To Integrate The Economy Of Two Countries And Asy
Flow Of Capital. Due To Free Flow Of Capital Results Into More Equality Between
The Countries.
Effective Capital Allocation:- It Helps To Allocate The Country’s Capital
Effectively By Providing Information Related To Different Areas.
Capital In need :- It Helps To Access The Capital Market Around The Word
Which Enables The Country To Lend Money In Good Times And Borrow Capital Ijn
Need.
Corrective Measures:- Due To Worldwide Cash Flows International Finance
Helps To Take Corrective Measures to Bad Government Policies.
BALANCE OF PAYMENT
Meaning: The Balance of Payment of a country is “a systematic record of all
economic transactions between the residents of the reporting country and the
residents of foreign countries during a given period of time”.
Like all double entry book keeping accounts it always balances i.e. sum of credit
entries & sum of debit entries.
In other words the balance of payment statement is a device for recording all
economic transactions within a given period of time between the residents of a
country and the residents of other countries.
EVOLUTION OF INTERNATIONAL MONETARY SYSTEM
The international monetary system is the framework within which countries
borrow, lend, buy, sell and make payments acress political frontiers. The framework
determines how balance of payments disequilibrium is resolved. Numerous
frameworks are possible and most have been tried in one forms or another. The
international monetary system can be broadly classified as below:
 FEATURES OF GOLD STANDARDS SYSTEM:
Each country was required to establish a central bank with an exclusive
authority to print and issue their respective currency notes.
The countries gold reserves were required to be in custody of central bank.
Each central bank was required to announce an official price of gold and to
provide an irrevocable guarantee to buy and sell unlimited quantity of gold at official
price.
Each currency note was required to contain an irrevocable promise to redeem
the note on demand against specified quantity of gold.
The total value of currency notes in circulation was required to be limited to the
value of gold with the central bank. Therefore there was a 1:1 relation between gold
with central bank and money supply in circulation.
ADVANTAGES OF GOLD STANDARDS :-
It is very easy system to implement and operate.
It provided fully secured payment and settlement system through transfer of
gold from deficit to surplus country.
It provided for a very high level of stability in exchange rates which promoted
international trade and investment.
It provided an in build mechanism for achieving equilibrium in an international
trade called “price species adjustments mechanism” (PASM)
DISADVANTAGE OF GOLD STANDARD:
It did not provide for revision of gold price in keeping with the increasing
manufacturing cost of gold.
It was a very inflexible system due to which it was difficult to adjust money
supply during economy stress in situation such as natural disaster, war, economy
depression etc.
PSAM was ineffective in situation where a country had recurring trade deficit.
It contributed to recessions due to which deficit countries suffered from lower
lower investments and employment opportunities.
 ADVANTAGES OF BWS:
The advantage of Bretton woods system was that the number countries had to
maintain only the reserve of dollars which helped them in overcoming the problem of
maintain gold reserve.
The countries could also earn interest on their dollar reserve unlike in the gold
reserve system.
The Bretton woods system sought to secure the advantage of the gold standard
without its advantage.
The gold standard imposed monetary discipline on the countries involved. Any
country experiencing inflation would have lost gold and therefore would have had a
decree in the amount of money available to spend.
The gold standard maintained fixed exchange rates. Fixed exchange rates were
seen as desirable because they reduced the risk of trading with other countries.
The united states had emerged from world II as the strongest economy in the
world. Unlike Europe and japan, the united states had experienced very little
destruction on its own land.
The benefits of the Bretton woods system were a significant expansion of
international trade and investment as well as a notable macroeconomic performance.
DISADVANTAGE OF BWS:
Weaknesses of the system were capital movement restrictions throughout the
Bretton woods years, government needed to limit capital flows in order to have a
certain extent of control
Another negative aspect was the pressure Bretton woods put on the united states,
which was not willing to supply the amount of gold the rest of the world demanded,
becauise the gold reserve declined and eroded the confidance in the dollar.
There was not enough gold available to allow people to buy all the new goods
and service that could be produced.and the gold that was available was mainly
located in the soviet union.
The success of Bretton woods system was essentially based on the unconditional
supply of dollars by US. However US could not do it for a long time as it was still
under the sytem of gold standard.
REASON FOR FAILURE OF BWS:
The BWS was merely a variant of gold exchange system and as such it was also
constrained by availability of gold.
As in the case of gold standard, this system also dish not provided for any
revision in the price of gold. Due to inflation, it became uneconomical to produce
gold.
The system did not provide for any revaluation of parties dur to which surplus
countries such as west Germany and Japan continued to enjoy export competitiveness
against the US economy.
The system did not provide for a revision in the price of gold in terms of USD.
Due to this, it was not possible to devalue the US dollar continued trade deficit.
Every member country had the right to accumulate dollar reserve and for that
obviously they had to consistently have a positive balance of trade with US.
The success of Breton woods system was essentially based on the unconditional
supply of dollars by US. Howe ever US could not do it for a long time as it was still
under the system of gold standards.
The continued trade deficit of the US created an over- supply of USD in the
international financial markets which reduced the acceptability of the USD.
FIXED EXCHANGE RATES:
The fixed exchange rate is the system in which the monetary authority fixes the
value of the domestic currency to a foreign currency or to a basket of currencies. It is
also called as hard peg or rigid peg and when one currency is pegged to a foreign
currency and its value is set at regular intervals according to some preset criteria of
the average exchange rate over the previous few months in the foreign exchange
market which makes the system more responsive to the market value of the domestic
currency this system of determining the va;ue of currency is called as crawling peg
system.
ADVANTAGE OF FIXED EXCHANGE RATE SYSTEM:
Contribute to the strength of the domestic currency: since there is no panic of
currencies fluctuations, fixed exchange rate creates assurance in the strength of the
domestic currency
Contributing to international economic integration: fixed exchange rate is a part
of more universal argument for national economic policies contributing to
international economic integration.
Control of inflation: as compared to floating system, there is control on inflation
as central bank controls the money supply and therefore keeps the inflation under
control.
Elimination of depreciation of currencies: under the fixed exchange system there
is no unhealthy practice of depreciation of currencies to capture international trade
like the floating system.
Encourage long-term capital flows: since uncertainty and risk of exchange rate
of exchange rates volatility is rare in case of fixed exchange rates volatility is rare in
case of fixed exchange rate, hence it encourage-long term capital flows.
Encourages international trade: commitment to a single fixed exchange rate
encourage international trade by making prices of goods concerned in trade more
predictable.
Monitor responsible financial policies: fixed exchange rate serve as a
commentator and imposes a discipline on monetary authorities to monitor responsible
financial policies within countries.
No fear of unfavourable effect of speculation: since there is no-fear of currencies
fluctuations, fixed exchange rate creates confidance in the strength of the domestic
currency and there is no fear of adverse effect of speculation on the exchange rate.
Relatively simpler system: it is a relatively simpler system and can be relied
upon as there are no frequent fluctuations in the exchange rate.
Comparatively more stable: the exchange rates remain comparatively more
stable than the flexible exchange rate
DISADVANTAGE OF FIXED EXCHANGE RATE SYSTEM:
Affects domestic economic stability: fixed exchange rate possibly will achieve
exchange rate stability but at the cost of domestic economic stability.
 Restriction on monetary policy formulation: monetary authorities lose the
freedom of monetary policy formulation to preserve exchange rate stability.
Managing foreign exchange reserve: the central bank may have to maintain
adequate reserve of the foreign currency every time leading to idle resources.
Misallocation of resources: fixed exchange rate system need difficult exchange
control mechanism which may lead to misallocation of resources.
International trade not promoted by fixed rates: the argument that fixed
exchange rates promote international trade is not supported by historical facts of
inter-war or post-war period.
International investment not promoted by fixed rates: the argument that long-
term international investments are encouraged under fixed exchange rate system is
not valid.
Fixed rates not necessary for currency area: this stable exchange rates are not
necessary for any system of currency areas.the sterling block functioned smoothly
during the thirties in spite of the fluctuating rates of the member countries.
Speculation not prevented by fixed rates: the main weakness of the stable
exchange rate system is that in spite of the strict exchange control, currency
speculation is encouraged.
Regular intervention of the central bank: this system requires regular
intervention of central bank to stabilize the rate; however, underlying problems of the
weak economy could not be solved through this method.
FLUCTUATING EXCHANGE RATES:
Fixed exchange rate regime is rarely practiced by any country at present. Almost
all countries, at present, have adopted some forms of flexible exchange rate policy. In
spite of making several attempts, when the various ways of stabilizing the exchange
rates went futile, IMF proposed the flexible exchange rate system in 1978.
The second amendment in IMF articles and it provided the monetary authorities
to introduce a new exchange rate system which should be indepented i.e which is not
based on gold valuation.
 When the exchange rate of a country is determined by the market forces i.e the
demand and supply of the currency, it is called as floating or flexible exchange rate. It
is called as free float or clen float.
ADVANTAGE OF FLOATING EXCHANGE RATE:
Autonomy of monetary authorities: autonomy of monetary authorities preserve
under floating exchange rate system as there is no target exchange rate to maintain.
Boost international liquidity: the system of flexible exchange rates eradicated
the need for official foreign exchange reserve, if the individual governments do not
empty stabilization funds to influence the rate.
Equilibrium provider to balance of payment: fluctuation in the exchange rate can
provide automatic adjustments for countries with a large balance of payments deficit.
Balance of payments on current account disequilibrium can automatically be restored
to equilibrium floating exchange rate regime and the scarcity or surplus of any
currency eliminated under floating exchange rate regime.
Flexible monetary policy: floating exchange rates gives the government/
monetary authorities’ flexibility in determining interest Rtes. This is because interest
rates do not have to be set to keep the value of the exchange rate within pre
determined bands.
Improvement in current account positions: this system provides for an automatic
mechanism to deal with country’s current account deficits will lead to fall in the
value of currency which will make imports costlier and exports cheaper.
Market forces of demand and supply: under the flexible exchange rate system
the foreign exchange rates are determined by the market forces of demand and
supply.
Optimum utilizing of monetary resources; flexible exchange rate enables
quicker adjustments in the rates depending upon the changes in the economic factors
in country.
Protects domestic economy: a fluctuating exchange rate sytem protects the
domestic economy from the shocks produced by the turmoil generated in other
countries.
 Reflects the true position of a country: it reflects the true position of a country as
the fluctuation in the exchange rate is caused by the changes in the macro-economic
factoes and is determined by the market forces of demand and supply of the currency.
support planned economic development: the flexible exchange rate system
promotes economic development and helps to achieve full employment in the
country.
DISADVANTAGE OF FLOATING EXCHANGE RATE:
Increases exchange rate volatility: market forces may fail to resove the
appropriate exchange rate and hence floating exchange rate regime may not provide
the desired result and may also guide to misallocation of resources.
Increases the exchange rate risk: unless sound hedging mechanism is there, the
importers and exporters may face uncertain exchange rate risk.
Inflationary pressures: flexible exchange rate system involves greater chance of
inflationary effect of exchange depreciation on domestic price level of a country.
Inflationary rise.
Makes the economy more vulnerable: it is unfeasible to have an exchange rate
system without official intervention. Government may not intervene, however
domestic monetary policy and fiscal policy would definitely influence the exchange
rate.
Monetary disorder in the economy: this system though has auto-mechanism to
correct cureent account deficits, but for the countries where demand for certain
products is inelastic, huge imports may lead to heavy deficits which may induce
inflation and monetary disorder in the economy.
Reduce the volume of international trade: volatile exchange rate introduces
sixeable uncertainty in export and import prices and a result to economic
development.
Serious impact on the economic structure: the system of flexible exchange rates
has serious impact on the economic structure of the company. Fluctuating exchange
rates cause changes in the price of imported and exported goods which, in turn,
destabilize the economy of the country.
 Speculative capital movements: speculative capital movements caused by
fluctuating exchange rates cause changes in the price of imported and exported goods
which, in turn, destabilize the economy of the country.
Worsen the balance of payments deficit; the elasticity in the international
markets is too low for exchange rate, variations to operate effectively in bringing
about automatic equilibrium.
CURRENCY AREAS:
In the wake of the collapse of the Bretton woods exchange rate system, the IMF
appointed the committee of twenty that suggested for various option for exchange
rate arrangement.
Now a days a wide variety of arrangements exist and countries adopt the
monetary system according to their own whims and fancies. That’s why some
analysts are calling is a monetary “non-system” de jure arrangements stands for
exchange arrangement a member of IMF notifies to the fund in accordance with
article IV, section 2(b) of the funds’s articles of agreement- and de facto (observed)
arrangements.
The IMF system classifies exchange rate arrangements primarily on he basis of
the degree to which the exchange rate is determined by the market rather than by
official action, with market- determined rates being on the whole more flexible.
EUROPEAN MONETARY SYSTEM:
EMS started in 1979: the decision was taken in 1978 by the German chancellor
and French president. European monetary system (EMS) was am arrangement
established in “1979 under the Jenkins European commission where most nations
of the European Economic Community (EEC) linked their currencies to prevent large
fluctuations relative to one another.
CURRENT EXCHANGE RATE ARRANGEMENTS:
In the wake of the collapse of the Bretton woods exchange rate system, the IMF
appointed the committee of twenty that suggested for various options for exchange
rate arrangements. Those suggetions were approved at jamacia during February 1976
ans were formally incorporated into the text of the second amendment to the articles
of agreement that came into force from april 1978.
Floating-independence and managed.
Pegging of currency.
Crawling peg.
Target-zone arrangements.
The IMF system classifies exchange rate arrangements primarily on the basis of
the degree to which the exchange rate is determined by the market rather than by
official action, with market- determined rates being on the whole more flexible, the
system distinguish among four major categories: hard pegs (such as exchange
arrangements); soft pegs ( including conventional currency board arrangements,
pegged exchange rates within horizontal bands, crawling pegs,stablized
arrangements, and crawl-like arrangements.
Hard pegs: establishing a fixed exchange rate between one national currency and
another national currency is called the ‘hard peg’ of a currency. A hard peg is
generally adopted by countries. As per the de facto classification by the IMF,25
countries follow a hard peg.
TYPES OF FOREIGN EXCHANGE QUOTATION
Bid and ask price:- in foreign exchange market there are buyers and sellers, one
party buy and one party sale. Quotes are made in the form of buy and sale. Buy
means bid and sale means ask.
Direct quote: direct quote also known as price quotations under the direct
quotation, the variations of the exchange rates are inversely related to the change in
the value of the domestic currency. When the value of the domestic currency rises,
the exchange rate is fall.
Forward quote: forward quote is a rate which applies in foreign exchange for
some transactions of purchase or sale on a specified future date. The buyers and seller
agree to do the the transactions on a future date and the rate will be fixed now for the
transaction, irrespective the rate on that future date.
Indirect quote: indirect quote is also known as the quantity quotation. Under
indirect quotation, the rise and fall of exchange rates are directly related to the
changes in value of the domestic currency
Inter-bank quote: the most professional way to do foreign exchange transaction
is inter-bank quote. In this system most of the professional broker gives quote,
European terms are a term where on the computer screen the trading screen appears.
It showa that the number of units of foreign currency appears.
Mid quote: this quote also knoen as reference rate. When convertibility.
Condition exists then the central banks follows the mid quote.it is the quote or price
which is the average of the bid and sk quot or price.
Spot quote: spot quote basically usefull when there is purchase or sale takes
place in foreign exchange and the payment or receipts are made on the spot, generally
within very short specified period, then it is called as spot quote.
Cross currency rate: when stocks are exchanged by using different currency
which are not official currency where the exchange quote in given then a cross
currency quote can be used.
Spread quote: this is also known as bid-offer spread. It is a quote at which the
participants will to buy or sale goods or services. It is divided in direct spread and
indirect spread when the ask price is greater than bid price then it is direct spread
quote but when the bid price is greater than ask price then it is called as indirct spread
quote.
FOREX TRANSACTION
Interbank market deals are conducted mainly over the telephone. If the price
quoted is acceptable, the deal between traders will move further in terms of amount
bought/sold, price identity of the party etc. in their respective banks will settle the
transactions with both the sides. Classification of rates in terms of settlement.
The day on which these transfers are effected is called the settlement date or the
value date. Classification of transactions based on value date.
Cash: cash rate or ready rate is the rate when the exchange of currencies takes
place on the date of the deal itself. There is no delay in payment at all.
Tom: it stands for tomorrow rate, which indicates that the exchange of
currencies takes place on the next working day after the date of the deal, and
therefore represented by T+1.
Spot: when the exchange of the currencies takes place on the second day after
the date of thedeal (T+2), it is called as spot rate. It applies to interbank transactions
that require delivery on the purchase currencies within two business days in exchange
for immediate cash payment for that currencies.
Forward: the forward rate is contractual rate between a foreign- exchange trader
and the trader’s client for delivery of foreign currencies sometimes in the future.