Introduction to International Financial Systems

1. Introduction to International Financial Systems Module-4 Prof srikanth venkataswamy

2. An Introduction to Financial Market Prof srikanth venkataswamy In economics, a financial market is a mechanism that allows people to easily buy & sell (trade) financial securities (such as stocks & bonds), commodities (such as precious metals or agricultural goods) and transact currencies .

3. Types of Financial Market Money Market Capital market Commodity Market Financial Market Derivatives Market Insurance Market Foreign Exchange Market Prof srikanth venkataswamy

4. Types of Financial Markets: The financial markets can be divided into different subtypes: • Commodity markets, which facilitate the trading of commodities. • Money markets, which provide short term debt financing and investment. • Derivatives markets, which provide instruments for the management of financial risk. • Futures markets, which provide standardized • Forward contracts for trading products at some future date; see also forward market. • Insurance markets, which facilitate the redistribution of various risks. • Foreign exchange markets, which facilitate the trading of foreign exchange. Prof srikanth venkataswamy

5. Business firms or organisations raise funds from investors in the form of equites and debts (collectively known as the capital structure) and further reinvest it into various investment schemes by carefully analyzing the returns in order to meet out their obligations relating to purchase of assets which provides them long term benefits of compensation. Prof srikanth venkataswamy

6. In finance: Investments • In finance, investment is the commitment of funds through collateralized lending, or making a deposit into a secured institution. • In contrast to investment; dollar cost averaging, market timing, and diversification are phrases associated with speculation. • Investments are often made indirectly through intermediaries, such as banks, Credit Unions, Brokers, Lenders, and insurance companies. Though their legal and procedural details differ, an intermediary generally makes an investment using money from many individuals, each of whom receives a claim on the intermediary. Prof srikanth venkataswamy

7. Trade: Business of any kind; matter of mutual consideration; affair; dealing. The business which a person has learned, and which he engages in, for procuring subsistence, or for profit; occupation; especially, mechanical employment as distinguished from the liberal arts, the learned professions, and agriculture; as, we speak of the trade of a smith, of a carpenter, or mason, but not now of the trade of a farmer, or a lawyer, or a physician Prof srikanth venkataswamy

8. FDI: Foreign Direct Investment Foreign Direct Investment, or FDI, is a type of investment that involves the injection of foreign funds into an enterprise that operates in a different country of origin from the investor. Foreign Direct Investment or FDI, is a measure of foreign ownership of domestic productive assets such as factories, land and organizations. This does not include foreign investments in stock markets. Instead, FDI refers more specifically to the investment of foreign assets into domestic goods and services. FDIs are generally favored over equity investments which tend to flow out of an economy at the first sign of trouble which leaves countries more susceptible to shocks in their money markets. Foreign direct investments have become the major economic driver of globalization, accounting for over had of all cross-border investments. Prof srikanth venkataswamy

9. FDI: Foreign Direct Investment The most profound effect has been seen in in developing countries, where yearly foreign direct investment flows have increased from an average of less than $10 billion in the 1970s to a yearly average of less than $20 billion the 1980s. From 1998 to 1999 itself, FDI grew from $179 billion to $208 billion and now comprise a large portion of global FDI. According to UNCTAD, spurred on by mergers and acquisitions and the internationalization of production in a range of industries, inward FDI for developing countries rose from $481 billion in 1998 to $636 billion in 2006. And China is at the forefront of FDI growth, followed by Russia, Brazil and Mexico. Prof srikanth venkataswamy

10. FDI: Foreign Direct Investment • FDIs do not only provide an foreign capital and funds, but also provides domestic countries with an exchange of skill sets, information and expertise, job opportunities and improved productivity levels. • The "Asian Tiger" economies such as China, South Korea, Singapore and the Philippines benefitted tremendously and experienced high levels of economic growth at the onset of foreign direct investment into their economies. • Given the high growth rates and changes to global investment patterns, the definition to FDI has evolved to include foreign mergers and acquisitions, investments in joint ventures or strategic alliances with local enterprises. Prof srikanth venkataswamy

11. Trends in Foreign Direct Investment (FDI) • Historically, FDI has been directed at developing nations as firms from advanced economies invested in other markets, with the US capturing most of the FDI inflows. • While developed countries still account for the largest share of FDI inflows, data shows that the stock and flow of FDI has increased and is moving towards developing nations, especially in the emerging economies around the world. • Aside from using FDIs as investment channel and a method to reduce operating costs, many companies and organizations are now looking at FDI was a way to internationalize. • FDIs allow companies to avoid governmental pressure on local production and cope with protectionist measures by circumventing trade barriers. The move into local markets also ensures that companies are closer to their consumer market, especially if companies set up locally-based (national) sales offices. Prof srikanth venkataswamy

12. Prof srikanth venkataswamy

13. Classifications of Foreign Direct Investment FDIs can be classified as; • Inward FDI and Outward FDI, depending on the direction of flow of money. • Inward FDI occurs when foreign capital is invested in local resources. The factors propelling the growth of inward FDI include tax breaks, low interest rates and grants. • Outward FDI, also referred to as "direct investment abroad", is backed by the government against all associated risk. Prof srikanth venkataswamy

14. Benefits of Foreign Direct Investment • One of the advantages of foreign direct investment is that it helps in the economic development of the particular country where the investment is being made. • This is especially applicable for developing economies. During the 1990s, foreign direct investment was one of the major external sources of financing for most countries that were growing economically. • It has also been noted that foreign direct investment has helped several countries when they faced economic hardship. Prof srikanth venkataswamy

15. Benefits of Foreign Direct Investment contd…. • For host countries, inward FDI has the potential for job creation and employment, which is often followed by higher wages. • Resource transfer, in terms of capital and technical knowledge, is also a key motivator that encourages inward FDI. • FDI has been used more as a market entry strategy for investors, rather than an investment strategy. • FDI growth has increased at a higher rate than the level of world trade as businesses attempt to circumvent protectionist measures through direct investments. • Additionally for investors, FDI provides the benefits of reduced cost through the realization of scale economies, and coordination advantages, especially for integrated supply chains. Prof srikanth venkataswamy

16. Benefits of Foreign Direct Investment contd…. • The preference for a direct investment approach rather than licensing and franchising can also been viewed in terms of strategic control, where management rights allows for technological know-how and intellectual property to be kept in-house.  • FDIs are favoured in particular because of its long term durability and commitment to a host countries economy and would be less susceptible to short term changes in market conditions, therefore ensuring a certain level of continuity and stability in the money flow. Prof srikanth venkataswamy

17. Disadvantages of Foreign Direct Investment • Many developing economies have tried to restrict, and even resist, foreign investments because of nationalist sentiments and concerns over foreign economic and political influence.  • One pertinent reason for this sentiment is that many developing countries, or at least countries with a history of colonialism, fear that foreign direct investment may result in a form of modern day economic colonialism, exposing host countries and leaving them and their resources vulnerable to the exploitations of the foreign company. Prof srikanth venkataswamy

18. Disadvantages of Foreign Direct Investment • While the levels of FDI tend to be resilient during periods of economic uncertainty, it has the potential of adversely affecting the net capital flow of a developing economy especially if it does not have a healthy and sustainable FDI schedule It is also often argued that • FDIs generate negative externalities in the labour market of the host economy. Why so? All firms are profit maximizing entities, and one way to achieve this is often the most direct approach of cost reduction. • FDIs may enter the host country for unique strategic reasons but there is ultimately the need to achieve returns on investments.  Prof srikanth venkataswamy

19. Disadvantages of Foreign Direct Investment • Evidence shows that multinational companies do pay a slight premium over local-term wages, but does this really benefit the host economy? Paying a premium for the price of labour may improve the consumption power of workers, but it also has the detrimental ability of disrupting the local employment market.  • When prices rise, supply increases while demand falls. Similarly, when the price of labour increase, wage premiums in this case, this creates a distortion and creates a disequilibrium in the labour market. Job matching stops being efficient and may even create unemployment.  Prof srikanth venkataswamy