SIKKIM MANIPAL UNIVERSITY,DE

Student Name: ASHISH BAJPAI

Registration No:
Subject Name: IFM

Course: MBA
LC Code:
Subject Code: IB0010

Q1- Discuss the goals of international financial management

Ans- Goals of International Financial Management:
Effective financial management is not limited to the application of the latest business
techniques or functioning more efficiently but includes maximization of wealth meaning
that it aims to offer profit to the shareholder, the owners of the businesses and to ensure
that they gain benefits from the business decisions that have been made. So, the goal
of international financial management is to increase the wealth of shareholders just like
in domestic financial management. The goals are not only limited to just the
shareholders, but also to the suppliers, customers and employees. It is also understood
that any goal cannot be achieved without achieving the welfare of the shareholders.
Increasing the price of the share would mean maximizing shareholders wealth.
Though in many countries such as Canada, the United Kingdom, Australia and
the United States, it has been accepted that the primary goal of financial management
is to maximize the wealth of the shareholders; in other countries it is not as widely
embraced. In countries such as Germany and France, the shareholders are generally
viewed as a part of the stakeholders along with the customers, banks, suppliers and so
on. In European countries, the managers consider the most important goal to be the
overall welfare of the stakeholders of the firm. On the other hand, in Japan, many
companies come together to form a small number of business groups known as
Keiretsu, including companies such as Mitsui, Sumitomo and Mitsubishi which are the
prosperity of their Keiretsu is the most critical goal for the Japanese managers.
However, it doesnt mean that the maximization of shareholders wealth is just
an alternative but it is a goal that a company seeks to fulfill along with other goals. The
maximization of shareholders wealth is a long term goal. If a firm does not treat the
employees properly or produces merchandises of poor quality, it cannot be expected
that such firms will be able to maximize the shareholders wealth. Only these firms can
stay in business for a long term and provide opportunities for employment that efficiently
produces what is demanded from them.
However, in recent times, as capital markets are becoming more integrated
and liberalized, managers in countries such as France, Germany and Japan have
started paying serious attention to the maximization of the shareholders wealth. For
instance, in Germany, companies can now repurchase stocks, if necessary for the
shareholders benefit.
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Q2. The key component of the financial system is the money market that acts as a
fulcrum of monetary operations.
Write down the important points under each category mentioned below.
a) Functions performed by money market
b) International interest rates
c) Standardized Global Market regulations.
Ans- Functions performed by money market:
One of the key components of the financial system is the money market that acts as a
fulcrum of monetary operations that are carried out by the Central bank while pursuing
the objectives of monetary policy. The maturity of such markets range from overnight to
a year and involves financial instruments that are considered as close substitute of
money. There are three broad functions that are performed by the money market.
1. For the demand and supply of short term funds, the money market provides an
equilibrating mechanism.
2. It helps the lenders and the borrowers of the short term funds in fulfilling the
borrowing and investment requirements at a competent market clearing price.
3. It offers an avenue to the central bank to intervence in influencing the cost of
liquidity and the quantum in the financial system which in turn transmits monetary
policy impulses to the real economy.
International Interest Rates:
Money market rates are interest rates used by banks for operations among
themselves. Money market enables the banks to trade their surpluses and deficits.
This rate is also commonly known as inter-bank rate. The rates for various countries
vary substantially. The reason for this substantial difference in rates is due to their
interaction of supply or availability of short term funds (bank deposits) in a particular
country versus the demand by borrowers for short term funds in that country. If the
supply is more than the demand the interest rate will be low. A typical case is of
Japan where the short term rates are very low for the same reason. On the other
hand, if the supply of short term funds is less, than the demand of rates will be high
as in the case of Australia.
LIBOR (London Inter Bank Offer Rate) is a rate which a first class bank in
London will charge from another first class bank for a short term loan. It is the most
commonly used benchmark. One more rate, (London interbank bid rate) is a rate
which a bank is willing to pay for deposits accepted from another bank.

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Standardized Global Market Regulations:
Regulations contribute to the development of international money markets because
these impose restrictions on local markets. Local investors and borrowers try to
circumvent the restrictions in local markets. Three most significant regulatory events
for creating more competitive global level playing field are given below:
1. Single European Act: This was one of the most significant events pertaining to
international banking. It was introduced in 1992 throughout the European Union
countries. The main features of this act are:
Capital can flow freely throughout Europe.
Banks can offer a wide variety of lending. Leasing and securities activities
in European Union.
2. The Basel I Accord: In July 1988, central bank governors of 12 countries agreed
on standard guidelines for banking regulation under The Basel Accord. As per
the guidelines of the Basel Accord, banks are required to maintain capital equal
to minimum of 4 per cent of their assets. For the purpose of this assessment, the
banks assets are weighted by the risk involved, i.e. more risky assets will have
higher required capital ratio. Items which are not appearing on the balance sheet
are also accounted so that banks cannot circumvent the provisions of the accord.
This applies to services which are not explicitly shown on the balance sheet.
3. The Base II Accord: The banking regulators those formed the Basel Accord
introduced a new accord called The Basel II Accord. The objective of this accord
is to rectify some inconsistencies that still exist in the earlier accord. For
example, banks in some countries require better collateral to back the loans. The
Base II Accord is aiming to resolve such differences amongst banks. Additionally,
this accord will also account for the operational risk. The operational risk is
defined by the Basel Committee as the risk of losses resulting from failure of
internal processes or system which are inadequate.

Q3. Thousands of years back the concept of bartering between parties was
prevalent, when the concept of money had not evolved.
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Explain on counter trade with examples
Answer- Introduction of counter trade:
Thousands of years ago, the concept of bartering between parties was prevalent, when
the concept of money had not evolved. A person could give say 100 bags of wheat and
get wood or coal, a certain quantity for cooking. These bartering contracts were
between individuals or small kingdoms. Bartering exists today also but at different level.
For example, Iran may give 100 million barrels of oil to France and get 5000 guns of
certain type in exchange.
Today, most business is transacted with money as medium. Trading between countries
is through respective currencies using international exchange rate.
The level of international trade is going up every year. All countries are trying to
export what they can in order to earn foreign exchange to be in a position to import what
they need.
In countertrade, there is exchange of goods between two parties in different
countries under two separate contracts in money terms.
Explanation of Different forms of counter trade:
Counter trade takes many different forms as explained below:
(i)
Barter: It is exchange of goods without the use of money. Typical
examples are:
(a) Oman exchange oil for air-conditions with Taiwan
(b) Sri Lanka exchange fish for mobile handsets with Germany
(ii)
Buy back: In this part, the payment of the price of contract is through
supply of related products. Typical examples are:
(a) A firm in China purchases plant & technology for manufacture of high
precision bearings from Germany, and the firm in Germany agrees to
buy a part of bearings produced by the plant in China.
(b) A firm establishes gas pipeline for another firm to transport gas and
produce electricity and in turn agrees to buy a portion of electric power
for prolonged period at predetermined terms.
(iii)
Counter purchase: In such cases, there is direct purchase of items as
exchange deals. Typical examples are:
(a) A firm in US sold soft drinks to Russian counterpart and imported
vodka in exchange.
(b) Canada sold wheat to Indonesia in exchange for import of rubber.
(c) A German firm sold machine tools to a firm in Romania in exchange for
import of hosiery items.
Examples:

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1. The exporting country sells high technology items at inflated prices and the items
which they import are disposed off to other countries at a discount, using a part
of high premium charged on their exports.
2. The middlemen in the counter trade agreements are usually shrewd traders who
exploit the political and social circumstances to obtain large gains for themselves.
3. The goods that are offered in countertrade are not the required items, because
the describable items have already been exported. For example, if Switzerland
sells high precision machines to Brazil, it may like Brazilian coffee beans in
exchange, but what it may get is only leather goods.

Q4. There are different techniques of exposure management. One is the Managing
Transaction Exposure and the other one is the managing operating exposure so
you have to explain on both Managing Transaction Exposure and Managing
Operating Exposure.
Ans- Explanation of Managing transaction exposure:

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Transaction exposure calculates gains or losses which occur after the current financial
compulsions according to terms of reference are resolved. Taken that the deal would
lead to a future inflow or outflow of foreign currency cash, any unprecedented
alterations in rate of exchange amid the period in which transaction is entered and the
time taken for it to settle in cash would guide to a change in worth of net flow of cash in
terms of the home currency. For example a transaction exposure of an Indian company
will be the account receivable which is associated with a sale denominated in US dollars
or the compulsion of an account payable in Euro debt.
In either case, the remedy might be worse than the disease!
(i)

(ii)

(iii)

Forward market hedge: If you might owe foreign currency in upcoming

future, be in agreement to purchase foreign currency in present by entering
into long position in a onward contract. If you might get foreign currency in
future, consent to sell it now by entering into small time position in a forward
contract.
Money market hedge: In order to hedge the payable foreign currency, a firm
can purchase a lump sum of that foreign currency and then sit on it for a long
period of time. This can be done in following ways:
The current value of the payable foreign currency can be bought.
The amount may be invested at the foreign rate.
The amount can be converted back at maturity. This ensures that the
investment grows enough to cover the payable foreign currency.
Option hedge: One possible shortcoming of both forward and money market
hedges is that the firm has to forgo the opportunity to benefit from favorable
exchange rate changes. The payable buys are called on the foreign currency
in order to hedge the currency.

Explanation of Managing operating exposure: Operating exposure is alternatively

known as economic. It evaluates the changes that occur in the current value of the firm.
The change in the current value may be a result of the change that takes place in
predicted operating cash flows on account of fluctuations in exchange rates.
They are similar in that they both deal with future cash flows. They differ in terms of
which cash flows management considers. Transactions exposure deals with the
predicted cash flows for future that have already been contracted and hence accounted
for.
Suppose an Indian MNC, such as Videocon, has sales in India, United States, China
and Europe and therefore, posts a continuing series of foreign currency receivables.
Sales and expenses that are already contracted for are traditional transaction
exposures.
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Some firms face operating exposure without even dealing in foreign exchange.
Consider an Indian perfume manufacturer who sources and sells only in the domestic
market. Since the firms product competes against imported perfumes it is subject to
foreign exchange exposure. It faces severe competition when rupee gains against other
currencies (here, euro), lowering the prices of imported perfumes.

Q5. Every firm is going on concern, whether domestic or MNC.

Explain the techniques of capital budgeting and the steps to determine cash
flows.
Ans- Techniques of Capital Budgeting: There are many techniques which can be
used to analyze the projects. These techniques can be broadly classified into
discounted cash flow techniques, which include net present value (NPV), internal rate of
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return (IRR), profitability index (PI) and discounted payback methods, and nondiscounted cash flow techniques which include payback and accounting rate of return
(ARR) methods. The most commonly and most widely accepted techniques is NPV
method. We now describe some of these techniques in brief and NPV method is greater
detail.
Net Present Value (NPV): In this method all future cash flows occurring in different time
periods are discounted to present value using opportunity cost of capital as discount
rate. Whenever there is a cash inflow, we take it with positive sign and cash outflow, we
take it as negative sign. If present value (PV) of cash inflows is greater than present
value (PV) of cash outflows the project can be accepted. However, if there are more
than one project and only one can be accepted then the project with highest differences
of PV of all cash inflow and PV of cash outflows is accepted. The difference of PV of all
future cash flows and initial investment is known as NPV. So, we can say that project
with positive NPV can be accepted and in case of more than one project, the project
with highest NPV will be accepted.
Internal Rate of Return: Internal rate of return is defined as that discount rate at which
NPV is equal zero. This internal rate of return is compared with opportunity cost of
capital. If IRR is greater than opportunity cost of capital the project can be accepted; if
IRR is less than opportunity cost of capital the project will not generate any extra returns
so it can either be accepted or rejected. The greater the magnitude by which IRR
exceeds the opportunity cost of capital the greater will be the profitability, so ranking of
projects can be done based on the magnitude of difference.
Profitability Index (PI): It is defined as the ratio of present value of all cash inflows
divided by the initial cash outflow. It is similar to NPV in the sense that it also uses
discounted cash flows and initial outflow but instead of subtracting initial cash outflow
from discounted cash flows, here we divide the discounted cash flows by initial cash
outflow. We accept the project if PI is greater than one, reject it if PI is less than one and
may or may not accept it if PI is equal to one.
Payback Period: This is a non-discounted cash flow technique. It finds out the time in
years in which the initial investment would be recovered. It is the easiest method as far
as computation is concerned but drawback being that it does not consider time value of
money. Mathematically, it is calculated by dividing initial cash outflow by annual constant
cash inflows.
Discounted payback period is a better method than payback period in the
sense that it considers the time value of money and discounts all future cash flows.
Determination of cash flow: We need to determine the incremental cash flows over
the existing cash flows which will take place by acceptance of the project under
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evaluation. Any expenses which are already incurred will not be included in cash flows.
Such expenses are called sunk costs.
The step of determining cash flows with accuracy is the most important step in
capital budgeting analysis as further process is dependent on it, but it is a difficult task
due to the following reasons:
1. Future is uncertain, and uncertainty gives rise to risks
2. Accounting information which is based on various assumptions is used as basis
to determine cash flows
3. Economic conditions may change suddenly due to some event
In any capital investment project there will be three main cash flows:
Initial cash outflow
Cash flows during the project. It may be inflow or a mix of inflow and
outflow
Final period cash flow; generally referred to as terminal cash flow

Q6. Write Short note on:

a. American Depository Receipts(ADR)
b. Portfolio
Ans- Explanation of ADR: It represents ownership in the shares of a non-US company
and trades in the American stock markets. ADRs enable American investors to buy
shares in foreign company without any issue of cross-border and cross-currency
transactions.

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ADRs carry price in American dollar, pay dividend in the same currency and can
be traded like any other share of US-based companies. Each ADR is issued by a US
depository bank and can represent one share. The owner of ADR has the right to obtain
the foreign stock it represents, but US investors are more interested in owning ADR as
they can diversify their investments across the globe. ADR falls within the regulatory
framework of the US and requires registration of the ADRs and the underlying shares
with the SEC.
Features of ADRs:
The following are the features of ADR:

ADR can be listed on American Stock Exchange.

A single ADR can represent more than one share. One ARD can be two shares
or any fraction also.
The holder of the ADRs can get them converted into shares.
The holders of ADR have no right to vote in the company.

Concept of Portfolio: Portfolio is the combination of assets so as to reduce the risk

by diversification.
There are two major types of risks that are as follows:
1. Systematic risk: It is also known as market risk. It is the risk common to all
securities and all companies. These risks cannot be diversified away and some
examples are interest rates, recession and wars.
2. Unsystematic risk: It is also called as the specific risk that is specific to the
individual asset and can be diversified away as we increase the number of
assets in our portfolio.
Diversification: It is a risk management technique that uses a wide variety of
investments in order to reduce the impact that any one security will have on the
overall performance of the portfolio. It means combining the securities into a portfolio
is such a way so as to reduce portfolio risk without the impact on the return.
Portfolio policy selecting securities and markets: Portfolio return and risk
measured are specific to the currency of investment. The return on a portfolio is a
weighted sum of returns on the assets comprising the portfolio, the weight being the
initial value of the share or asset in the portfolio. The return on the assets has two
components:

Dividend
Capital gain

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Risk reduction and international portfolio diversification: As per the portfolio
theory, the investors have to choose between lower expected returns for lower risks.
Whenever there is an imperfect correlation between returns on different securities, the
risk is reduced by diversification of portfolio. The extent to which risk is reduced
depends upon the correlation between the returns of the securities held in the portfolio.

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