International Financial Management

M.B.S – Final
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Chapter -1
1) What is International Finance?
Ans: The term International Finance is defined as the economic
interaction among different nations involving the monetary payments
and the exchange of currency. The basis of international finance is
foreign exchange, including foreign exchange markets and exchange
rates.

2) Discuss the importance of International Finance /

International Financial Management.
Ans: International financial management deals with the financial
decision taken in the area of International business. Today’s world
axed the trade barriers significantly over the years, as a result of which
International trade grew multiple. Naturally the financial involvement
of trader’s, exporters, importers, and the quantum of the cross country
transactions surged significantly. All these require proper management
of international flow of fund. For this, International financial
management has become important.

The second reason is fast expansion of multinational companies. And

by their operation, the cross country flow of fund increased
substantially. The two way flow of funds, outward in the form of
investment and inward in the form of repatriation divided, royalty, and
technical service fees require proper management. And for doing it,
efficient international financial management is must.

The third reason is that the complexity of financial decision of MNC.

Today’s MNC are more interested in maximizing the value of global
wealth. And to mange it quite well, International financial management
helps a lot.

The fourth reason is, a vast magnitude of lending international and

regional development asks. The movement of fund from developed
countries and the reverse movement of funds in form of interest and
amortization payments need proper management.

The final reason is, we are growing international and form of financial
instruments and markets became international. The need of citizen
currently has no political border. So to fulfill their wants, the risks over

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foreign currencies become huge. With the efficient international
financial management, we can find the most suitable technique to be
applied at a particular moment and in a particular case in order to
hedge risk.
3) What is Multinational Company? What economic roles do
they play?
Ans: Multinational Company or transnational company is defined as a
company which maintains its assets and operations in more than
country. A multinational corporation often has a long supply chain that
may, for example require the acquisition of raw materials in one
country, a product’s manufacture in another country, and it’s retail
sale in a third country. A multinational often globally manages its
operations from a main office in its home country. They recruit human
resources from their operational countries or may from any part of the
world. Multinationals create wealth in every country where they
operate, which ultimately benefits workers as well as shareholders. For
example – Toyota, Nokia, Honda, Volkswagen etc.
Economic roles played by Multinationals:
1) Economic growth and employment: MNC bring inward
investment in such country which is not their home base. This
huge investment is likely to provide a boost, not only to the local
economy but also to the national economy.
2) Skills, production techniques and improvements in the human
capital: MNC’S new ideas and new techniques can help to
improve the quality of production and help boost the quality of
human capital in the host country. Many will not only look to
local labor but also provide them with training and new skills to
help them improve productivity and efficiency.
3) Availability of quality goods and services in the host country:
Production in a host country may be primarily aimed as to
export. However the inward investment might have been made
to gain access to the host country to circumvent trade barriers.
In the case of many Japanese car manufacturers the investment
made into UK production has enabled them to get a foothold in
the EU and to avoid tariff barriers.
4) Tax Revenue: For operating in host country, MNC has become a
tax regime of the country.
5) Improvement of infrastructure: In addition to the investment in a
country in production or distribution facilities, a company might
also invest in additional infrastructure facilities like road, port
etc. That can provide benefits for the whole country.

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 MNC plays a vital role for the economy. It not only provides us
employment, revenues, good products but also provide positive
images for the country. That is really very important for showing
stability to gain foreign investment more. But it is to be needed to
check that MNC is not supposed to take the whole profit they made by
using the host country.

3) Identify the main goal of Multinational Company and the

potential conflicts with that goal.
Ans. The main goal of multinational company is to maximize
shareholder’s wealth. But if the company wants to maximize their
earnings in the near future, rather than to maximize shareholder’s
wealth, the firm’s policies would be different.
Potential conflicts: Conflicts encountered in meeting goals -

1) Agency problems larger for MNC ARE than purely domestic firms
because:
a) monitoring more difficult because of geographic distance
b) Different cultures
c) MNC size
d) Subsidiary managers may maximize the value of their
subsidiary but not of the MNC as a whole

2) Centralized vs. decentralized management

a) centralized reduces agency costs because it gives parent
more
control; downside is that local managers may be better informed

b) Decentralized management increases agency costs but may

result in better decisions

c) Internet may facilitate monitoring of foreign subsidiaries

3) Corporate control used to reduce agency problems

a) executive compensation with stock
b) threat of hostile takeover
c) monitoring by large shareholders

4) Describe the key theories which justify international

business.

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Ans: Theories which justify the international business are provided
below –
● Theory of comparative advantages:
- Countries specialize in the production of goods; they can produce
with relative efficiency and trade for other products.
● Theory of imperfect markets:
- Factors of production (labor and other resources) are immobile.
● Theory of product cycle:
- Firm introduces product in home market, then exports it, then
establish a subsidiary, and then differentiate the product.

5) Explain the common methods used to conduct international

business.
Ans: ● International Trade:
- Export and Import
- Low risk
- Internet facilities advertising and sales
● Licensing:
- Obligate firm to provide its technology in exchange for
fees or other benefits. E.g. - ATT&T and Nynex
Corporation had licensing to build India’s telephone
system.
●Franchising:
Obligates firm to provide a specialized sales or service
strategy, support assistance and possibly an initial
investment in exchange for periodic fees
●Joint Ventures:
A venture that is jointly owned and operated by two or
more firms
Allow firms to apply comparative advantage (e.g., General
Mills and Nestle)
●Acquisitions of Existing Operations:
Acquire a firm in a foreign country to penetrate foreign
markets
Advantage: full control over foreign business
Disadvantage: risky because of large investment and
uncertainty
Some firms make partial acquisitions, but these do not
allow full control even though they are less risky
●Establishing New Foreign Subsidiaries:
Establish new operations in foreign country to penetrate
market
Advantage: can tailor exactly to firm’s needs

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 Disadvantage: must establish customer base, unfamiliarity
with local customs
●Methods requiring a direct investment are referred to as direct
foreign investment (DFI):
Includes franchising, joint ventures, acquisitions, and
foreign subsidiaries

6) What are the typical reasons why MNC’S expand

internationally?
Ans: The reasons are provided below –
Opportunities of – 1) Higher growth potential
2) Larger investment opportunity set
3) Lower borrowing costs due to more funding
source

4) Result in lower cost of capital and higher

returns for projects.

Exposure to international risk –

1) Less exposure to domestic economy
2) Can avoid political risk if any.
Opportunities in various regions –
1) Europe: a) Single European Act 1987, b)
inception of the euro.
2) Latin America: a) NAFTA, b) GATT
3) Asia: Large population base.

6) Identify the risk faced by multinational companies which

expand internationally?
Ans: Risks faced by multinational company is provided below –
1) Exposure to exchange rate movements
2) Exposure to foreign economics
3) Exposure to political risk
Synopsis:
1) Exposure to exchange rate movements: Exchange rates are the
amount of one country’s currency needed to purchase one unit
of another currency. Dealing with very large amount of money by
multinational companies in their transactions, the rise or fall of a
currency can mean getting a surplus or deficit in their balance
sheet. One type exchange risk is “Transaction Risk”. If a
company sells products to an overseas customer it might be
subject to transaction risk. Other type of exchange rate risk is

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 called “translation risk”. This risk relates to cases where large
manufacturing companies have subsidiaries in other countries.
2) Exposure to Political Risk: For MNC, political risk refers to the risk
that a host country will make political decisions that will prove to
have an adverse effect on MNC’S profit and goals. Two types of
political risk –
a) Macro risk (Refers to an adverse action that will affect all
foreign firms) and - b) Micro Risk (Refers to an adverse action
which will affect particular industrial sector or business).
Terrorism is a major political risk recently facing by the MNC so
much.

3) Exposure to Foreign Economics: When MNC’S enter foreign

markets to sell products; the demand for these products is
dependent on the economic conditions in those markets. Thus the cash
flows of the MNC are subject to foreign economic conditions.

7) Explain the agency problem by Multinational Companies.

Why might the agency cost be larger for a MNC’s than for a
domestic firm?
Ans: The agency problem reflects a conflict between decision making
managers and the owners of the MNC. Agency cost occurs in an effort
to assure that managers act in the best interest of the owners. Again if
the subsidiaries made their own decisions, the agency cost would be
higher since the parent needs to monitor the subsidiaries to assure
that their decisions were intended to maximize shareholder’s wealth.
The agency costs are normally larger for MNC’S than purely domestic
firms for the following reasons. First – MNC incur large agency costs in
monitoring of distant foreign subsidiaries. Second – Foreign subsidiary
managers raised in different cultures may not follow uniform goals.
Third – The sheer size of the larger MNC’s would also create large
agency problems.

8) Describe the constraints which interfering the MNC’s goal.

Ans: When financial manager of MNC attempt to maximize their firm’s
value, they are confronted with various constrains that can be
classified as environmental, regulatory or ethical in nature.
1) Environmental Constrains: Each country enforces its own
environmental constrains. Some countries may enforce more of
these restrictions on a subsidiary whose parent is based in a
different country. Building codes, disposal of production waste
materials, and pollution controls are examples of restrictions that
force subsidiaries to incur additional costs. Many European

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 countries have recently imposed tougher antipollution laws as a
result of severe pollution problems.
2) Regulatory Constrains: Each country also enforces its own
regulatory constrains pertaining to taxes. Currency convertibility
rules, earnings remittance restrictions, and other regulations that
can affect cash flows of a subsidiary established there.
3) Ethical Constrains: There is no census standard of business
conduct that applies to all countries. A business practice that is
perceived to be unethical in one country may be totally ethical in
another. For example – Bribes, Sexual product in Arab countries.

9) Explain why political risk may discourage international

business?
Ans: Political risk refers to the risk that a host country will make
political decisions that will prove to have an adverse effect on
multinational’s profit and goals. Basically political risk increases the
rate of return required to invest in foreign projects. Some foreign
projects would have been feasible if there was no political risk, but will
not be feasible because of political risk. There are various types of
political risk which discourage international business. We can make a
matrix form about this –

Government Risk Instability Risk

Firm Specific - Discriminatory Regulations - Sabotage
risk - Breach of contract - kidnappings
- Terrorism
- Firm-specific
boycotts
Country level - Mass Nationalizations - Mass labor strikes
risk - Regulatory changes - Urban rioting
- Currency Inconvertibility - Civil wars.

With effective political risk management by CFO’s can make significant

impact to the removal process of such discouragements.

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