Unit-4

International Financial Management

Meaning of International Financial Management:

International Financial Management (IFM) is concerned with the management
of International Business (IB) related financial functions, commonly known as the
international financial functions.
The commonly stated goal of a firm is to maximise its value and thereby
maximise shareholder wealth. This goal is applicable not only to firms that focus on
domestic business, but also to firms that focus on international business. In fact, many
firms have expanded their international business as a means of enhancing their value.
Since foreign markets can be distinctly different from local markets, they create
opportunities for improving the firm's cash flows.
Many barriers to entry into foreign markets have been reduced or removed
recently, thereby encouraging firms to pursue international business (producing and/or
selling goods in foreign countries). Consequently, many firms have evolved into
Multinational Corporations (MNCs), which are defined as firms that engage in some
form of international business. Their managers conduct international financial
management, which involves international investing and financing decisions that are
intended to enhance the value of the MNC.
An understanding of international financial management is crucial not only for
the largest MNCs with numerous foreign subsidiaries but also Tor other firms that
conduct international business. Even smaller U.S. firms commonly generate more than
20 per cent of their sales in foreign markets, including AMSCO International
(Pennsylvania), Ferro (Ohio). Interlake

Objectives of Financial Management: -

The financial management is generally concerned with procurement, allocation
and control of financial resources of a concern. The objectives can be -
1. To ensure regular and adequate supply of funds to the concern.
2. To ensure adequate returns to the shareholders which will depend upon the
earning capacity, market price of the share, expectations of the shareholders.

1 DCM CLASSES; Mansarovar, Jaipur. Mob./WhatsApp: 9414992261,7014527893

 3. To ensure optimum funds utilization. Once the funds are procured, they should
be utilized in maximum possible way at least cost.
4. To ensure safety on investment, i.e., funds should be invested in safe ventures
so that adequate rate of return can be achieved.
5. To plan a sound Capital Structure-There should be sound and fair composition of
capital so that a balance is maintained between debt and equity capital.

Nature of International Financial Management: -

International financial management is a distinct field of study and certain
features set it apart from other fields. The important distinguishing Features of
international finance are explained below:

1. Foreign Exchange Risk: -An understanding of foreign exchange risk is essential

for managers and investors in the modern day environment of unforeseen
changes in foreign exchange rates. In a domestic economy this risk is generally
ignored because a single national currency serves as the main medium of
exchange within a country. When different national currencies are exchanged for
each other, there is a definite risk of volatility in foreign exchange rates. The
present International Monetary System set up is characterized by a mix of floating
and managed exchange rate policies adopted by each nation keeping in view its
interests. In fact, this variability of exchange rates is widely regarded as the most
serious international financial problem facing corporate managers and policy
makers.
2. Political Risk- Another risk that firms may encounter in international finance is
political risk. Political risk ranges from the risk of loss. (or gain) from unforeseen
government actions or other events of a political character such as acts of

2 DCM CLASSES; Mansarovar, Jaipur. Mob./WhatsApp: 9414992261,7014527893

 terrorism to outright expropriation of assets held by foreigners. MNC must assess
the political risk not only in countries where it is currently doing business but also
where it expects to establish subsidiaries.
3. Expanded Opportunity Sets—When firms go global, they also tend to benefit
from expanded opportunities which are available now. They can raise funds in
capital markets where cost of capital is the lowest. In addition, firms can also gain
from greater economies of scale when they operate on a global basis.
4. Market Imperfections- The final feature of international finance that
distinguishes it from domestic finance is that world markets today are highly
imperfect. There are profound differences among nations: laws, tax systems,
business practices and general cultural environments. Imperfections in the world
financial markets tend to restrict the extent to which investors can diversify their
portfolio. Though there are risks and costs in coping with these market
imperfections, they also offer managers of international firm abundant
opportunities.

Scope of International Financial Management: -

Scopes of international financial management are the following:

1. Foreign Exchange Market—The foreign exchange market is the place where

money denominated in one currency is bought and sold with money denominated
in another currency.
2. Currency Convertibility—The discussion of the foreign exchange market was
based on the assumption that the currencies of various countries are freely
convertible into other currencies. This assumption is not valid. Many countries

3 DCM CLASSES; Mansarovar, Jaipur. Mob./WhatsApp: 9414992261,7014527893

 restrict the ability of residents and non-residents to convert the local currency into
foreign currency, making international businesses more difficult. A country's
currency is said to be freely convertible when the country's government allows
both residents and non-residents to purchase unlimited amounts of foreign
currencies with the local currency. A currency is non-convertible when neither
residents nor non-residents are allowed to convert local currency into a foreign
currency.
3. International Monetary System- Every country needs to have its own monetary
system and an authority to maintain order in the system. Monetary system
facilitates trade and investment. India has its own monetary policy that is
administered by the Reserve Bank of India. Primarily, RBI aims at controlling
inflation and money supply and maintaining an interest rate regime that is helpful
to economic growth.
4. Balance of Payments—Balance of Payments (BOP) is a statistical statement
that systematically summarizes, for a specified period of time, the monetary
transactions of an economy with the rest of the world. BOP data help measure
financial transactions between residents of the country and residents of all other
countries. Transactions include exports and imports of goods and services,
income flows, capital flows, and gifts and similar one sided transfer payments.
5. International Financial System—The international financial system consists of
the numerous rules, customs, instruments, facilities, markets, and organizations
that enable international payments to be made and funds to flow across borders.
In recent years, the international financial system has experienced tremendous
growth. New financial instruments have been created, and the volume of
transactions has exploded. The dramatic metamorphosis of international financial
markets is driven by technological changes, the growth in world trade, and the
breakdown of barriers to financial (capital) flows.

Functions of International Financial Management: -

International financial management refers to the financial function of an
overseas business. Specifically, the finance function of an international business deals
with the following points:

4 DCM CLASSES; Mansarovar, Jaipur. Mob./WhatsApp: 9414992261,7014527893

1. Investment Decisions—When a company innovate a specific technology and
its product is mature in the markets abroad or when the company wants to reap
the location advantage in a foreign country, it sets up an affiliate there. Whatever
the motivation behind foreign investment or foreign manufacturing, the company
evaluates the cash inflow and outflow during the life of the project and makes
investment only when the net present value of cash flows is positive. Besides, it
takes into account the foreign exchange risk and the political risk involved. IFM
thus studies the different theories of overseas production, the various strategies
of investment, capital budgeting decision and evaluation of foreign exchange and
political risks pertaining to overseas investment.
2. International Working Capital Decisions—When foreign operation begins, the
parent company evaluates different sources of working capital so that the cost of
financing is the cheapest. In this context, an international company maintains an
edge over a domestic company in so far as it can easily reach the international
financial market or can siphon resources from one subsidiary to another. When
targeting sources of funds, it has also to decide the size of current assets
because these facts have a close link with the cost of production and the overall
profitability of the firm. IFM helps in taking a correct decision regarding the size
of working capital and suggests a mechanism for its management. It also deals
with how foreign trade is financed.
3. Financial Decisions—Any investment needs rising of funds. The MNCs take
advantage of the many innovations which have taken place in the international
financial market and IFM guides them on how to take advantage of these. It deals
with how different instruments are issued to raise funds and how swaps are used

5 DCM CLASSES; Mansarovar, Jaipur. Mob./WhatsApp: 9414992261,7014527893

 for minimizing the cost of funds. The nature and management of interest-rate
exposure to form a part of IFM.
4. International Accounting and Taxation Decisions—International accounting
forms an integral part of IFM. It analyses the techniques for consolidation of
financial statements of the various affiliates, international audit, international
financial reporting and international taxation. Transfer pricing is an important
area of international accounting as it is used for lowering the overall burden of
taxes and tariff as well as for working capital management. Similarly,
international tax system should be so designed that it fosters economic efficiency
and does not come in the way of the cross border movement of goods and factors
of production.

Importance of International Financial Management: -

International financial management deals with the financial decisions taken in
the area of international business. The growth in international business is, first of all,
evident in the form of highly inflated size of international trade. In the immediate post-
war years, the general agreement on the trade and tariffs was set up in order to boost
trade. It axed the trade barriers significantly over the years, as a result of which
international trade grew manifold. Naturally, the financial involvement of the trader's
exporters and importers and the quantum of the cross country transactions surged
significantly. All this required proper management of international flow of funds for
which the study of international financial management came to be indispensable.
Not unexpectedly, the second half of the twentieth century witnessed the
emergence and fast expansion, of multinational corporations. Normally, with the
growth of international trade, the products of the exporter become mature in the
importing countries. When the product becomes mature in the importing countries, the
exporter starts manufacturing the product there so as to evade tariff and to supply it at
the least cost. Thus, it would not be wrong to say that the emergence of the
multinational companies was the byproduct of the expansion in world trade. There
were some countries in the developing world too which were liberal in hosting the
multinational companies. They imported technology on a big scale and built up their
own manufacturing base. As a result, the company went international. Thus,
multinational company's emergent not only in developed countries but also in the

6 DCM CLASSES; Mansarovar, Jaipur. Mob./WhatsApp: 9414992261,7014527893

developing world and because of their operation the cross country flow of funds
increased substantially. The two-way flow of funds, outward in the form of investment
and inward in the form of repatriation divided, royalty, technical service fees, etc.,
required proper management and so the study of international financial management
become a real necessity. The need of international financial management has
increased because of:
(1) Increase in the volume of international trade.
(2) Globalisation of businesses.
(3) Increase in movement of capital and labour with lesser restrictions.
(4) Increase in speed of communication and transport.
(5) Emergence of international capital and money markets.

7 DCM CLASSES; Mansarovar, Jaipur. Mob./WhatsApp: 9414992261,7014527893