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IBO 06

IBO 06. International Business Finance. BLOCK 1. International Financial System. It involves the management of three processes (I) the adjustment of balance of payments positions, including the establishment and alteration of exchange rates;

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IBO 06

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  1. IBO 06 International Business Finance

  2. BLOCK 1 International Financial System

  3. It involves the management of three processes (I) the adjustment of balance of payments positions, including the establishment and alteration of exchange rates; (2) the financing of payments imbalances among countries by the use of credit or reserves; and (3) the provision of international money (reserves). International Monetary System | | <document classification>

  4. Evolution of International Monetary System • Gold Standard-period prior to the 1914-18 was considered as gold standard • International debt settlement in gold • It was the foundation of international trading system • When the country had surplus then gold flowed into central bank • When the country had deficit then gold flowed outside the country | | <document classification>

  5. Bretton Woods in IMF agreement • International conferrence was held in Bretton Woods in 1944 • It was signed by 44 nations • IMF was to be established to promote consultation and collaboration on international problems • To lend to member countries | | <document classification>

  6. Regional Financial Institution • Asian Development Bank • African Development • European Investment Bank • Inter-American Development Bank • Atlantic Development Group for Latin America • Arab Fund for Economic And Social Development • European Bank for reconstruction and Development | | <document classification>

  7. International Financial Markets • International financial markets is concerned with buying and selling currencies banking transactions and capital market operations • International markets can be money (trading with the instruments less than 1 year)and capital market(deals with instruments maturity exceeds 1 year) | | <document classification>

  8. International financial market include Euro Market • Euro is the official currency of the eurozone which includes Australia, finland, Germany, Greece, Italy, Spain etc. • Euro market quotes two rates Offered Rate (LIBOR), Bid rate (LIBID) | | <document classification>

  9. International Debt Instruments • Euro Notes is a promissory note with short term maturities • Euro Commercial papers large corporations with strong credit ratings is to raise funds by issuing CP. It is issued as unsecured security by commercial and financial institution . The prominent markets for commercial papers are US,Canada,UK,Japan,Australia • Medium Term Notes • Floating Rate Notes • Euro Bonds | | <document classification>

  10. International Banking • International Money Transfer Mechanism • Correspondent bank • Foreign branch • Foreign agencies • Foreign subsidiary banks • Representative offices | | <document classification>

  11. Terms of account in international banking • Two are used • Nostro • Vostro | | <document classification>

  12. Money Market Instruments • Treasury Bills • Commercial papers • Banker’s acceptance • Certificate of deposits • Repurchase agreements | | <document classification>

  13. International Banking Risks and Capital Adequacy Requirements • Capital adequacy consists of • Core Capital (Tier I) • Supplemental Capital (Tier II) consists of • Secret reserves • Revaluation reserves • General provision and loss reserves • Hybrid debt capital instruments • Subordinated Debt | | <document classification>

  14. International transactions and balance of payment • BOP=all inflows-all outflows on current account and capital account • Value of visible exports can be balanced against the value of visible imports • Value of invisible exports can be balanced against the value of invisible imports to determine invisible balance • Balance of payment consists of balance of investment and other capital flows | | <document classification>

  15. Adjustment Policies • Unilateral Adjustments • Bilateral adjustments • Regional adjustments • Multilateral adjustments | | <document classification>

  16. BLOCK 2 Foreign Exchange Risk Management

  17. Foreign Exchange Markets • Foreign exchange market is the market where one currency is exchanged for another currency • Foreign currency market can be domestic as well as international • Currencies are also traded in the form of derivative contracts such as swaps,options,futures • Outcry method replaced by screen based trading • Foreign exchange rate is the rate at which one currency is traded in exchange for another in the forex market • In free market freely movement of prices as per the demand and supply | | <document classification>

  18. In regulated market exchange rates are regulated and controlled • Forex markets are least partially regulated | | <document classification>

  19. Foreign Exchange Quotations • Direct Quotations • Indirect Quotations • Cross Rates | | <document classification>

  20. Foreign Exchange Transactions • Trade transaction • Interbank transactions • Spot transactions • Forward transactions | | <document classification>

  21. Determination and Forecasting of Exchange Rate Approaches to exchange rate • Purchasing power parity It states prices of a similar products of two different countries should be equal when measured in common currency • Interest rate parity The forward discount/premium is app. equal to the interest differential between currencies • The Fisher Effect • The International Fisher Effect | | <document classification>

  22. Currency Risk Management • Risk means the variability from the most likely happening. • Types of currency risk • Translation Risk • Transaction Risk • Economic Risk • Political Risk • Interest rate Risk | | <document classification>

  23. Derivatives • Derivatives are financial instruments whose prices derived from the prices from the prices of other financial instruments. The action of managing risk is called derivatives • Hedging is the technique by which uncertainities can be reduced. | | <document classification>

  24. Derivative Instruments • Forward Contract and Forward Rate Agreements • Future Contracts • Currency Options • Currency Swaps • Interest Rate Swaps | | <document classification>

  25. Transaction Exposure • Transaction exposure is on transactions that a firm has already entered into and that are denominated in a foreign currency, the firm could incur future gains or losses owing to the unanticipated exchange rate fluctuations | | <document classification>

  26. Techniques of Transaction Exposure • Forward market hedge • Money market hedge • Exposure netting • Currency risk sharing • Leading and lagging • Currency options currency futures • Currency swaps | | <document classification>

  27. Translation Exposure • It refers to the amount of risk facing as a result of the need to translate financial statements prepared in one currency into statements in another currency | | <document classification>

  28. Currency Translation methods • Current/non current method • Monetary/non-monetary method • Temporal method • Current rate method | | <document classification>

  29. Designing a hedging strategy • Funds flow adjustment • Forward contracts • Exposure netting | | <document classification>

  30. Economic Exposure • It is related with cash flow risk • Cash flow means net dividend and liquidation proceeds available to the owners • Free cash flow • Future earnings of the company • It is based on the extent to which the value of a company as measured by the present value of its expected future cash flows will change when exchange rate change | | <document classification>

  31. Managing Economic Exposure Marketing initiatives • Market selection and segmentation • Pricing strategy • Promotional strategy • Product strategy Production initiatives • Input mix • Shifting production among plants • Plant location • Raising productivity Financial initiatives | | <document classification>

  32. BLOCK 3 Investing in Foreign Operations

  33. Corporate Strategy and Foreign Direct Investment • Multinational Corporation is a corporate undertaking whose industrial operating are based in more than two countries and whose decision making process is based on the overall strategy | | <document classification>

  34. Foreign Direct Investment • FDI involves the setting up of subsidiaries in foreign countries for the domestic production of commodities which previously imported fro the parent company. • It is more concerned to developing countries where financial resources have more constraint. • It makes an opportunity of proper globalization concept and deployment of resources and technology in world wide. • In competitive advantage scenario it gives an opportunity of marketing expansion and as well as production and operation activity leveraged. | | <document classification>

  35. CORPORATE STRATEGY JOINT VENTURES AND GLOBAL EXPANSION | | <document classification>

  36. It is often used in the context of a company's plan of action that causes it to allocate its scarce resources (specially finance) over time "to get from where it is to where it wants to go". "Strategy" has been depicted as the base of a cold triangle (three hard elements), superimposed by four soft elements. in the well-known "SEVEN S's MODEL“ Corporate strategy, in association with structure (organisation chart) and systems (procedures), is supposed to achieve superordinate goals (significant objectives/guiding concepts) through skills (distinctive capabilities), staff (personnel) and style (organisational culture). | | <document classification>

  37. Indian Regulation of Foreign Direct Investment and Guidelines • In December 1996, the Reserve Bank of India allowed automatic approval of FDI up to74% in nine categories : i) Electricity generation and transmission:Non-conventional energy generation and transmission; iii) Maintenance of roads, bridges, ports, harbours, runways, waterways, tunnels, pipelines. industrial and power plants: iv) Pipeline transport except POL (petroleum, oil and lubricant) and gas; v) Water transport | | <document classification>

  38. Foreign Exchange Regulation:FERA AND FEMA • FERA(Foreign Exchange Regulation Act) 1973 was inacted on the recommendations 47th report of Law Commission.After reviewing FERA FEMA was enacted in 1999 • FERA considered offence as criminal offence while FEMA considered civil offence • Appellate board replaced by Appellate Tribunal and Special Director(appeals) under FEMA • The defaulters shall be liable to civil imprisonment • The penalty is thrice the sum involved or upto two lakfh rupees | | <document classification>

  39. International ProjectAppraisal • Projects involve long term expenditure, the amount of expenditure being generally large. An important characteristic of projects is Once committed, it is difficult to liquidate without substantial loss. • An obvious implication of it is that the cost of error of judgement in case of projects is very high. • So,an international investor should appraise a project as 'stand alone' | | <document classification>

  40. Project Appraisal Project appraisal is whether or not to put the money in the project it means comparing return on investment with the cost of the funds. Only if the return is higher than the cost of funds, it would make sense to put the money in a project. • Under the financial appraisal, market-price-based cash flows accruing to the project arc considered. • Under the economic appraisal, economic prices or shadow price based cash flows accruing to the project are considered. • Under the social appraisal, economic prices based cash flows accruing to project and its social and environmental context are considered. • Technological appraisal involves assessment of the requirements of the • construction, commissioning, operation and maintenance and abandonment phases of the project. | | <document classification>

  41. Project Appraisal Technique Discounted Cash Flow technique • NPV • IRR Non-Discounted Cash Flow Technique • Pay back Period • Accounting Rate of Return | | <document classification>

  42. Adjusted Present Value Technique • It includes • Initial investment • Project’s Remittable Cash Flow • Contribution of subsidies and concession to project • Tax savings and other transfers to parent | | <document classification>

  43. Cost of Capital for Foreign Investment • Cost capital is the measure of financial performance of a firm • Cost capital is the minimum risk adjusted return required by investors for undertaking an investment • the net present value of the future cash flows of the project exceeds or at least be equal to the project's cost of capital. This cost is used as a discount rate. | | <document classification>

  44. Weighted Average Cost of Capitalfor Foreign Projects • The weighted average cost of capital (WACC) of the project, is the cost of equity combined with the after-tax cost of debt. • KO = ko( I - L ) K e + L i d ( l - t ) • Where, • KO = Weighted cost of capital • L = debt ratio (debt to total assets) of the parent company • Ke = cost of the equity capital • id (1-t) = after-tax cost of the debt. | | <document classification>

  45. Cost of Various Sources of Funds • Cost of Parent Company's Funds • KO' = KO + (I-L) (Ke'-Ke) KO* = Cost of capital in changed conditions of riskiness Ke' = Cost of equity based on new perceptions of riskiness Ke = Company's cost of equity capital L = Debt ratio of the parent company | | <document classification>

  46. The Cost of Retained Earnings • ks= Ke x (1 - t) • where • Ks = cost of retained earnings • t = tax rate • Cost of Foreign Debt : Rfd = Rf(l-t)(l-d)-d where Rfd = Cost of foreign debt Rf = ' Foreign interest rate 1 d = Percentage depreciation of foreign currency | | <document classification>

  47. Cost of Equity Capital • Cost of equity is the minimum rate of return necessary to induce investors to buy or hold the • Rr = Rf+ Rp • Rr = required rate of return • Rf = risk free rate of return • Rp = risk premium | | <document classification>

  48. Dividend Valuation Model • Ke=Div1/Po+g Ke=company cost of equity capital Div1=expected dividend in year 1 Po=current price of share g=growth rate of dividend | | <document classification>

  49. Capital Asset Pricing Model • Ri = Rf+bi(Rm-Rf) • Ri=equilibrium expected return for asset I • Rf=risk free rate • Rm=expected return on market portfolio • Bi=covariance between return and market portfolio | | <document classification>

  50. Political Risk And Tax Aspects • Political risk is defined as the possibility of unwanted consequences of political activity and events. There are three major categories of political risks. (a) forced disinvestment (b) unwelcome regulation and (c) interference with operations. Forced disinvestment occurs when a host government acquires assets of a company against company's will. | | <document classification>

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