Introduction to International Finance - Dr. J. Mexon

International Finance, MNC, Business Methods

1. International Finance
Management
–Unit 1
Dr. J. Mexon P. Rayan

2. Introduction
•Internationalfinanceisthesetofrelationsforthe
creationandusingoffunds(assets),neededfor
foreigneconomicactivityofinternationalcompanies
andcountries.
•Assetsinthefinancialaspectareconsiderednotjust
asmoney,butmoneyasthecapital,i.e.thevaluethat
bringsaddedvalue(profit).Capitalisthemovement,
theconstantchangeofformsinthecyclethatpasses
throughthreestages:themonetary,theproductive,
andthecommodity.
•So,financeisthemonetarycapital,moneyflow,
servingthecirculationofcapital.Ifmoneyisthe
universalequivalent,wherebyprimarilylabourcosts
aremeasured,financeistheeconomictool.

3. •Thedefinitionofinternationalfinanceisthecombinationof
monetaryrelationsthatdevelopinprocessofeconomic
agreements-trade,foreignexchange,investment-between
residentsofthecountryandresidentsofforeigncountries.
•Financialmanagementismainlyconcernedwithhowto
optimallymakevariouscorporatefinancialdecisions,suchas
thosepertainingtoinvestment,capitalstructure,dividend
policy,andworkingcapitalmanagement,withaviewto
achievingasetofgivencorporateobjectives.Whenafirm
operatesinthedomesticmarket,bothforprocuringinputsas
wellassellingitsoutput,itneedstodealonlyinthedomestic
currency.

4. •Whencompaniestrytoincreasetheir
internationaltradeandestablishoperations
inforeigncountries,theystartdealingwith
peopleandfirmsinvariousnations.Onthis
regards,asdifferentnationshavedifferent
currencies,dealingwiththecurrencies
becomesaproblem-variabilityinexchange
rateshaveaprofoundeffectonthecost,
salesandprofitsofthefirm.

5. Relevance of International Finance
•Internationalfinanceisanimportanttooltofindthe
exchangerates,compareinflationrates,getanidea
aboutinvestingininternationaldebtsecurities,
ascertaintheeconomicstatusofothercountries
andjudgetheforeignmarkets.
•Exchangeratesareveryimportantininternational
finance,astheyletusdeterminetherelativevalues
ofcurrencies.Internationalfinancehelpsin
calculatingtheserates.
•Variouseconomicfactorshelpinmaking
internationalinvestmentdecisions.Economic
factorsofeconomieshelpindeterminingwhether
ornotinvestors’moneyissafewithforeigndebt
securities.

6. •UtilizingIFRSisanimportantfactorformanystages
ofinternationalfinance.Financialstatementsmade
bythecountriesthathaveadoptedIFRSaresimilar.
Ithelpsmanycountriestofollowsimilarreporting
systems.
•IFRSsystem,whichisapartofinternationalfinance,
alsohelpsinsavingmoneybyfollowingtherulesof
reportingonasingleaccountingstandard.
•Internationalfinancehasgrowninstaturedueto
globalization.Ithelpsunderstandthebasicsofall
internationalorganizationsandkeepsthebalance
intactamongthem.

7. •Aninternationalfinancesystemmaintains
peaceamongthenations.Withoutasolid
financemeasure,allnationswouldworkfor
theirself-interest.Internationalfinancehelpsin
keepingthatissueatbay.
•Internationalfinanceorganizations,suchas
IMF,theWorldBank,etc.,provideamediators’
roleinmanaginginternationalfinancedisputes.

8. Finance Function -Objectives
1.Assessing the Financial Requirements
2.Proper Utilisation of Funds
3.Increasing Profitability
4.Maximising Value of Firm

9. Scope of International Finance
•Itisimportantwhiledeterminingtheexchangerates
ofthecountry.Thiscanbedoneagainstthe
commodityoragainstthecommoncurrency.
•Itplaysacrucialroleininvestinginforeigndebt
securitiestohaveaclearideaaboutthemarket.
•Thetransactionbetweencountriescanbesignificant
inassessingtheeconomicconditionsoftheother
country.
•Thearbitrageintax,risk,andpriceduetomarket
imperfectionscanbeusedtobookgoodprofitswhile
transactingininternationaltrade.

10. Features of International Finance
1)Expanded Opportunity To Business:
2)Foreign Exchange Risk:
3)Imperfect Market:
4)Political Risk:

11. Multinational Company
•Amultinationalcompanyisonewhichis
incorporatedinonecountry(calledthehome
country);butwhoseoperationsextendbeyondthe
homecountryandwhichcarriesonbusinessin
othercountries(calledthehostcountries)in
additiontothehomecountry.
•Itmustbeemphasizedthattheheadquartersofa
multinationalcompanyarelocatedinthehome
country.
NeilH.Jacobydefinesamultinationalcompanyas
follows:
•“Amultinationalcorporationownsandmanages
businessintwoormorecountries.”

12. Features of MNC
(i)Huge Assets and Turnover:
(ii)International Operations Through a
Network of Branches:
(iii)Unity of Control:
(iv)Mighty Economic Power:
(v)Advanced and Sophisticated Technology:
(vi)Professional Management:
(vii)Aggressive Advertising and Marketing:
(viii)Better Quality of Products:

13. Growth of MNC
•Astheworldeconomyisopeningupwithafallinregulatory
barrierstoforeigninvestment,bettertransportand
communications,freecapitalmovements,etc.,international
companiesarefindingiteasiertoinvestwheretheychooseto
cheaply,andwithlessrisk.
•Moreover,thedevelopingcountriesnolongerconsiderthe
presenceofMNCstobesynonymouswithalossoftheir
sovereignty.ItisnowrealizedthatMNCsaremerelyapartofa
muchwiderforcethatisintegratingtheworldeconomy.
•Overtheyears,foreigndirectinvestmentbyMNCsinthe
developingcountrieshasbeensteadilyontherise,fromaslow
as19%oftotalflowsin1990,to30%in1994.

14. Themainfactorswhichhavecontributed
towardsthegrowthofmultinational
corporationsaregivenbelow:
•MarketExpansion:ThegrowthofGDP
andpercapitaincomeinvarious
countriesledtoincreasingdemandfor
goodsandservices.Companiesin
developedeconomies,explainedtheir
operationsoverseastoexploitthe
expandingmarketsabroad.

15. •MarketingSuperiorities:Multinationalsenjoythe
followingmarketingsuperioritiesoverthefollowing
overthedomesticcompanies:
a) Availabilityofmorereliableandup-to-date
informationaboutmarketconditions.
b)Reputationinthemarketduetopopularbrands
andimage.
c) Moreeffectiveadvertisingandsalespromotion
techniques.
d)Widedistributionnetwork.
e)Quicktransportationandwarehousingfacilities.

16. •FinancialSuperiorities:Multinationalsare
financiallysuperiortodomesticcompaniesinthe
followingrespects:
a)Hugefinancialresources.
b)Moreeffectiveandeconomicalutilisationoffunds
throughtransferofexcessfundsfromonecountryto
another.
c)Easyaccesstoforeigncapitalmarkets.
d)Easymobilisationofhighqualityresourcesof
differenttypes.
e)Accesstointernationalbanksandfinancial
institutions.

17. •TechnologicalSuperiorities:MultinationalshavestrongR&
Ddepartments.Theycaninventandinnovatenewproducts
andprocessesmoreeasilyandfrequently.Thisprovides
themanedgeovernationalcompanies.Developing
countriesinvitemultinationalsforadvancedtechnologydue
tothefollowingreasons:
a)Developingcountriesdonothavetheresourcestodevelop
advancedtechnologyandthelevelofindustrialisationislow.
b)Theyareunabletoexploittheirrichmineralandother
naturalresourcesduetoshortageoffundsandlowlevel
technology.
c)Theydonothaveadequateforeignexchangereservesto
importrawmaterials,capitalequipmentandtechnologyon
theirown.

18. Different Problems faced by the
Multinational Companies (mnc’s)
•Market Imperfections:
•Tax Competition:
•Political Instability:
•Market Withdrawal:
•Lobbying:

19. Problems between Domestic and MNC
•DIFFERENTECONOMICANDLEGALSTRUCTURE
•DIFFERENTCURRENCYDENOMINATIONS
•DIFFERENTLANGUAGES
•CULTURALDIFFERENCES
•ROLEOFGOVERNMENTS
•POLITICALRISK

20. International Business Activities/Methods
Internationalbusinessoccursinmanydifferentformats:
•Themovementofgoodsfromcountrytoanother(exporting,
importing,trade)
•Contractualagreementsthatallowforeignfirmstouseproducts,
services,andprocessesfromothernations(licensing,franchising)
•Theformationandoperationsofsales,manufacturing,researchand
development,anddistributionfacilitiesinforeignmarkets
Thestudyofinternationalbusinessinvolvesunderstandingtheeffects
thattheaboveactivitieshaveondomesticandforeignmarkets,
countries,governments,companies,andindividuals.Successful
internationalbusinessesrecognizethediversityoftheworld
marketplaceandareabletocopewiththeuncertaintiesandrisksof
doingbusinessinacontinuallychangingglobalmarket.

21. Thechallengingaspectofinternationalbusiness,however,is
thatmanyfirmscombineaspectsofbothmulti-domesticand
globaloperations:
•Multi-domestic–Astrategicbusinessmodelthatinvolves
promotingproductsandservicesinvariousmarketsaround
theworldandadaptingtheproduct/servicetothecultural
norms,tastepreferencesandreligiouscustomsofthe
variousmarkets.
•Multinational–Abusinessstrategythatinvolvesselling
productsandservicesindifferentforeignmarketswithout
changingthecharacteristicsoftheproduct/serviceto
accommodatetheculturalnormsorcustomsofthevarious
markets.
Thefivetypesofinternationalbusinessesare:1.Exporting2.
Licensing3.Franchising4.ForeignDirectInvestment(FDI)5.
JointVenture

22. 1.Exporting:Exportingisoftenthefirstchoicewhen
manufacturersdecidetoexpandabroad.
Exportingmeanssellingabroad,eitherdirectlyto
targetcustomersorindirectlybyretainingforeign
salesagentsor/anddistributors.Eithercase,
goingabroadthroughexportinghasminimal
impactonthefirm‘shumanresource
managementbecauseonlyafew,ifatall,ofits
employeesareexpectedtobepostedabroad.
Exportingisthepracticeofshippinggoodsfrom
thedomesticcountrytoaforeigncountry.The
sellerofsuchgoodsandservicesisreferredtoas
an―exporterwhereastheoverseasbasedbuyer
isreferredtoasan―importer

23. 2.Licensing:Licensingisanotherwaytoexpand
one‘soperationsinternationally.Incaseof
internationallicensing,thereisanagreement
wherebyafirm,calledlicensor,grantsaforeignfirm
therighttouseintangible(intellectual)propertyfora
specificperiodoftime,usuallyinreturnforaroyalty.
Licensingofintellectualpropertysuchaspatents,
copyrights,manufacturingprocesses,ortradenames
aboundacrossthenations
•Comparedtotheotherpotentialentrymodelsfor
foreignmarketentry,licensingisrelativelylowrisk
intermsoftime,resources,andcapital
requirements.

24. •Alicensor‘inalicensingrelationshipistheowner
oftheproduct,service,brandortechnologybeing
licensed.Andalicensee‘isthebuyerofthe
produce,service,brandortechnologybeing
licensed.Alicensor(i.e.thefirmwiththe
technologyorbrand)canprovidetheirproducts,
services,brandand/ortechnologytoalicenseevia
anagreement.Thisagreementwilldescribethe
termsofthestrategicalliance,allowingthelicensor
affordableandlowriskentrytoaforeignmarket
whilethelicenseecangainaccesstothe
competitiveadvantagesanduniqueassetsof
anotherfirm.Thisispotentiallyastrongwin-win
arrangementforbothparties,andisarelatively
commonpracticeininternationalbusiness.

25. Advantages:
•Licensingisarapidentrystrategy,allowingalmostinstant
accesstothemarketwiththerightpartnerslinedup.
•Licensingislowriskintermsofassetsandcapital
investment.Thelicenseewillprovidethemajorityofthe
infrastructureinmostsituations.
•Localizationisacomplexissuelegally,andlicensingisaclean
solutiontomostlegalbarrierstoentry.
•Culturalandlinguisticbarriersarealsosignificantchallenges
forinternationalentries.Licensingprovidescriticalresources
inthisregard,asthelicenseehaslocalcontacts,masteryof
locallanguage,andadeepunderstandingofthelocal
market.

26. Disadvantages:
•Lossofcontrolisaseriousdisadvantageinalicensing
situationinregardstoqualitycontrol.Particularlyrelevantis
thelicensingofabrandname,asanyqualitycontrolissueon
behalfofthelicenseewillimpactthelicensor‘sparent
brand.
•Dependingonaninternationalpartneralsocreatesinherent
risksregardingthesuccessofthatfirm.Justlikeinvestingin
anorganizationinthestockmarket,licensingrequiresdue
diligenceregardingwhichorganizationtopartnerwith.
•Lowerrevenuesduetorelyingonanexternalpartyarealso
akeydisadvantagetothismodel.(Lowerrisk,lowerreturns.)

27. 3.Franchising:Franchisingiscloselyrelatedto
licensingandisaspecialformofit.Franchisingisan
optioninwhichaparentcompanygrantsanother
company/firmtherighttodobusinessina
prescribedmanner.Afranchisee‘isaholderofa
franchise;apersonwhoisgrantedafranchise.Anda
franchiser‘isapersonwhograntsfranchises.
Franchisingdiffersfromlicensinginthesensethatit
usuallyrequiresthefranchiseetofollowmuch
stricterguidelinesinrunningthebusinessthandoes
licensing.

28. •Advantagesoffranchising(forthefranchiser)
includelowcostsofentry,alocalized
workforce(culturallyandlinguistically),anda
highspeedmethodofmarketentry.
Disadvantagesoffranchising(forthe
franchiser)includelossofsome
organizationalandbrandcontrol,aswellas
relativelylowerreturnsthanotherstrategic
entrymodels(withlowerrisk).

29. 4.ForeignDirectInvestment:FDIispracticedby
companiesinordertobenefitfromcheaperlabour
costs,taxexemptions,andotherprivilegesinthat
foreigncountry.FDIistheflowofinvestmentsfrom
onecompanytoproductioninaforeignnation,with
thepurposeofloweringlaborcostsandgainingtax
incentives.FDIcanhelptheeconomicsituationsof
developingcountries,aswellasfacilitateprogressive
internalpolicyreforms.
Foreigndirectinvestment(FDI)isinvestmentinto
productioninacountrybyacompanylocatedin
anothercountry,eitherbybuyingacompanyinthe
targetcountryorbyexpandingoperationsofan
existingbusinessinthatcountry.

30. •FDIisdoneformanyreasonsincludingtotake
advantageofcheaperwagesinthecountry,special
investmentprivileges,suchastaxexemptions,
offeredbythecountryasanincentivetogaintariff-
freeaccesstothemarketsofthecountryorthe
region.Foreigndirectinvestmentrefersto
operationsinonecountrythatarecontrolledby
entitiesinaforeigncountry.Inasense,thisFDI
meansbuildingnewfacilitiesinothercountry.

31. 5.JointVenture:Whentwoormorepersonscome
togethertoformapartnershipforthepurposeof
carryingoutaproject,thisiscalledajointventure.In
thisscenario,bothpartiesareequallyinvestedinthe
projectintermsofmoney,timeandefforttobuild
ontheoriginalconcept.Whilejointventuresare
generallysmallprojects,majorcorporationsusethis
methodtodiversify.
Sincethecostofstartingnewprojectsisgenerally
high,ajointventureallowsbothpartiestosharethe
burdenoftheprojectaswellastheresultingprofits.

32. •Sincemoneyisinvolvedinajointventure,it
isnecessarytohaveastrategicplaninplace.
Inshort,bothpartiesmustbecommittedto
focusingonthefutureofthepartnership
ratherthanjusttheimmediatereturns.
Ultimately,shorttermandlongterm
successesarebothimportant.Toachievethis
success,honesty,integrityand
communicationwithinthejointventureare
necessary.

33. INTERNATIONAL FINANCIAL
ENVIRONMENT
1. Foreign Exchange Market
2. Currency Convertibility
3. International Monetary System
4. International Financial Markets
5. Balance of Payments