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Ques 1: What is International Finance? Briefly discuss the distinguish features of International Finance. Ans 1:- A multinational Corporation (MNC) is a company involved in producing and selling goods and service in more than one country. It usually consists of a parent company located in its home country with numerous foreign subsidiaries. As business expands the awareness of opportunities in foreign markets also increases. This, ultimately, evolves into some of them becoming MNCs so that they can enjoy the benefits of international business opportunities. Knowledge of International Finance is crucial for MNCs in two important ways. First, it help the companies and financial managers to decide how international events will affect the firm and what steps can be taken to gain from positive developments and insulate from harmful ones. Second, it helps the companies to recognize how the firm will be affected by movements in exchange rates, interest rates, inflation rates and asset values. The consequences of events affecting the state markets and interest rates of one country immediately show up interdependent financial environment which exists around the world. Also, their have been close links between money and capital markets. All this makes it necessary for every MNC and aspiring manager to take a close look at the ever changing and dynamic field of international Finance. Distinguishing features of International Finance:International finance is a distinct field of study and certain features set it apart from other fields. The important distinguish features of international finance are discussed below:Foreign Exchange Risk:-

An understanding of the foreign exchange risk is essential for managers and invested in the modern day environment of unforeseen changes in foreign exchange rates. In a domestic economy this risk is generally ignored because a single national currency serves as the main medium of exchange within a country. When different national currencies are exchanged for each other there is a definite risk of volatility in foreign exchange rates. The present international Monetary system is characterized by a mix of floating and managed exchange rate polices adopted by each nation keeping in view its interests. In
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International Financial Management (FM-406) Contact: 92533-50008, 94164-43238

fact, this variability of exchange rates is widely regarded as the most serious international financial problem facing corporate managers and policy maker. At present, the exchange rates among some major currencies such as the US dollar, British Pound, Japanese Yen and the Euro fluctuate in a totally unpredictable manner, exchange rates were fluctuated since the 1970s after the fixed exchange rates were abandoned. Exchange rate variation affect the profitability of firms and all firms must understand foreign exchange risks in order to anticipate increased competition from imports or to value increased opportunities for exports. Expanded Opportunities Sets:-

When firms go global, they also tend to benefit from expanded opportunities which are available now. They can raise funds in capital markets where cost of capital is the lowest. In addition, firms can also gain from greater economies of scale when they operate on a global basis. Market Imperfections:The final feature of he international finance that distinguishes it from the domestic finance is that world markets today are highly imperfect. There are profound differences among nations law, tax systems, business practices and general cultural environments, imperfection in the world financial markets tend to restrict the extent to which investors can diversify their port jobs. Though there are risks and cost in coping with these market imperfections, they also offer managers of international firms abundant opportunities. Thus, the job of the manager of MNC is both challenging and risky. The key to such management is to make the diversity and complexity of the environment work for the benefit of the firm.

Ques 2:- Briefly explain the evolution the International Monetary System? Ans 2:- Evolution of the International Monetary System can be analyzed in four stages as follows:1) Gold Standard, 1876-1913 2) Inter-war Years, 1914-1944 3) Bretton Woods Systems, 1945-1973 4) Flammable exchange Rate Regime since 1973
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International Financial Management (FM-406) Contact: 92533-50008, 94164-43238

1)

The Gold Standard 1876-1913:The fundamental principle of the classical gold standard was that each country should set a par value its currency in terms of gold and them try to maintain this value. Thus, each country had to establish the rate at which its currency could be converted to the weight of gold. Also, under the gold standard, the exchange rate between any two currencies was determined by their gold content. Thus, the three important features of the gold standard were, First, the government of each country defines its national monetary unit in terms of gold. Second, free import or export of gold and third two way convertibility between gold and national currencies at a stable rates. These conditions were met during the period 1875-1914. The united states, for example declared the dollar to be convertible to gold at a rate of $20.67/ounce of gold. The British pound was pegged at 4.2474/ ounce of gold. Thus the dollar pound exchange rate would be determined as follows:$20.67/ounce of gold = $4.86656/ 4.2474/Ounce of gold Each countrys government then agreed to buy or sell gold at its own fixed parity rate on demand. Thus helped to preserve the value of each industrial currency in terms of gold and hence, the fixed partner between currencies. Under this system, it was extremely important for a country to back its currency value by maintaining adequate resources of gold. Because of the rigidity of the system, it was a matter of time before major countries decided to abandon the gold standard, starting with the United Kingdom in 1931 in the midst of a worldwide recession. With a 12% unemployment problem. 2) Inter war years, 1914-1944 The gold standard as an International Monetary System worked well until World War I interrupted trade flows and distorted the stability of exchange rates for currencies of major countries. There was widespread fluctuation in currencies in terms of gold during Word War I and in the early 1920s. As countries began to recover from the war and stabiles their economies, they made several attempts to return to the standard. The United States returned to gold in 1919 and the United Kingdom in 1925. The key currency involved in the attempt to restore the international gold standard was the pound sterling which returned to gold in 1925 at the old mint parity exchange rate of $4.87/ . From 1934 till the end of World War II, exchange rates were theoretically determined by
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International Financial Management (FM-406) Contact: 92533-50008, 94164-43238

each currencys value in terms of gold. World War II also resulted in many of the Worlds major currencies closing their convertibility. The only major currency that continued to remain convertible was the dollar. 3) The Bretton Woods System, 1945-1972:

The negotiations at Bretton Wood made recommendations in 1944: - Each nation should be at liberty to use macro-economic policies for full employment. - A monetary system was needed that would recognize that exchange rates were both a national and an international concern. The establishment of International Monetary System created two new institutions:- IMF and World Bank. The basic purpose of this new monetary system was to facilitate the expansion of world trade and to use the US dollar as a standard of value. Thus the main points of the post war system evolving from the Bretton Woods conference were:A new institution, IMF would be established in Washington DC. The US Dollar would be designated as reserve currencies, and other nations would maintain their foreign exchange reserves principally in the form of dollars or pounds. Each fund member would establish a par value for its currency and maintain the exchange rates for its currency within one percent of par value.

A fund member could change its par value only with fund approval and only if the countrys balance of payments was in fundamental disequilibirium This system worked without major changes from 1947 till 1971. the system however suffered from a member of inherent structural problems. There was imbalance in the roles and responsibilities of the surplus and deficits nations. 4) The Flamb exchange Rate Regime, 1973- Present

Since 1973, most industrial concerns & many other developing countries allowed their currencies to float with government intervention, whenever necessary, in the foreign exchange market. The alternative exchange rate system which followed are as follows:Page : 4/25

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Crawling peg:-

A cross between a fixed rate system and a fully flexible system are the semi-fixed systems such as the crawling peg. This differ from fixed rates because of their greater flexibility in terms of the exchange rate movements. Flexible (Floating) system:-

Under a flexible or floating system, the market force, based on demand and supply determines a currencys value. A surplus in a country immediate higher prices, mass reserve, and opportunities costs. In addition, too much money on reserve leads to a loss of investment opportunities. On the other hand, a countries deficit will lower its currency value. In the absence of government intervention, the float is said to be clean. It becomes dirty when there is a control bank intervention to influence exchange rates, which is a common action, especially by those with inflation and trade problems. Critics of floating exchange rates contend that the system causes uncertainty which discourages trade while promoting speculation.

Ques 3:Discuss the various methods which MNCs adopt to increase international business? Ans 3:- Foreign Direct Investment is investment made by a transnational corporation to increase its international business. When firms become multinational, they undertake FDI. Direct Foreign Investment is a common method of engaging in international business. But this method is generally expensive. However, there are several alternatives methods of entering foreign markets that are less risky and also involve a smaller initial outlay than FDI. The various alternatives are: a) b) c) d) A joint venture Merges and acquisitions Licensing Franchising

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a)

Joint Venture:A joint venture between a multinational firm and a host country partner is a viable strategy if one finds the right local partner, eg. Consider a firm in USA that has expertise in the technology to build automobiles and plans to establish business in West Germany. As this firm is not familiar with German rules and codes, it may consider a joint venture with a German Firm. These two firms could then combine to establish a business in West Germany that would not have been possible by either individual firm. Some of the advantage of joint venture are:The local partner understands the customs, cultural restrictions and various institutions of the local environment. For the multinational firms to acquire knowledge on its own, it might take a considerable period of time with a lot of problem attached to it. The local partner can provide competent management both at the top and also at the middle level. The contracts and reputation of the local partner may help the foreign firm in gaining access to the capital market. If the purchase of the investment is to target local sales, the foreign form may benefit from a venture that is partially locally owned. The above gains a list of advantages of a joint venture between a MNC and a host country if, and only if, one finds the right local partner.

In certain situation, MNCs fear interference by the local partner in certain decision areas. The important area of conflict are:Political risk increases if a wrong partner is chosen. There may be difference in views of various issues like the need to distribute cash dividends, amount of retained earnings etc between the local & foreign partners. IN some cases, control of financing can be a potential source of conflict. How much to disclose and what amount of financial disclosure is necessary need to be decided between the local firm and the foreign firm. But in case of a joint venture, financial disclosure is governed by the rules of the host country.
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b)

Mergers and Acquisitions/Cross Border Acquisitions

Firms are maintained to engage in cross border mergers and acquisitions to increase their competitive positions in the world market by acquiring special assets from other firms or using their own assets on a larger scale. FDI usually takes place through green field investments which involve building new production facilities in a foreign country or through cross border acquisition which involve buying existing foreign business. Synergistic gains may or may not arise form cross border acquisitions depending on the motive of the acquiring firms. Gains will result when the acquired merger is motivated to take advantage of market imperfections. A cross border merger has the following advantages as against green field investments. It is a cost effective way to capture advanced and valuable technology rather that developing it internally. It is also an easy and quicker way to establish an opportunity preserve in a host country. Economies of scale and synergistic benefits can be achieved with the merger. Foreign exchange exposure is reduced. As against these advantages, a cross border merger may have the following problems. Cultural differences may prevent the joining of two organizations of different customs, values & nationality. Labor problems can arise because of favoritism unequal union contracts, seniority etc. The price paid by the acquirer may be too high and the method of financing too costly. Strategic alliances are currently very popular all over the world as a way of conducting international business. Such alliance are specially popular in areas where the cost of resources and development is high and timely introduction of improvements is important. e.g. consider the strategic alliance between crisit and standard and poor. Both firms are in the credit rating industry. Both firms have retained them separate individual identity and the strategic alliance between the two mainly refers to sharing of knowledge, helping each other develop professionally in their area of specialization.

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C)

Licensing: Licensing is a popular method used by MNCs to profit from foreign markets without the need to commit sizeable funds. In licensing, a local firm in the host country producers the goods to the licensing corporations specification. When the goods are sold, a portion of the revenues, as specified by the agreement are sent to the licensor. The main advantages of licensing are:Transportation costs are avoided as exporting is not required. Direct foreign investment is not required as a local firm handles production in the host country.

The advantages of licensing are:It is difficult to ensure quality control of the local firms production process. License fees are generally lower than DFI profits although the return on the investment might be higher. D) Franchising In this method, an individual firm is allowed to sell its products in a specific territory. The firm usually revives an initial fee plus periodic royalty payments in return MC Donald and Pizza Hut have franchise all over the world. -

Ques 4: Briefly explain have an MNC can calculate its cost of equity capital? Also explain how the weighted cost of capital for an MNC can be calculated? Ans 4:- Cost of capital for a domestic firm is the rate that must be earned in order to satisfy the required rate of return of the firms investors. Simply put, it is the minimum acceptable rate of return for capital investments. If there are two firms with the same returns on their investments. The firm with the lower cost of capital will be valued higher as the residual value to shareholders will be greater. Since countries posses different economic characteristics and business environments, an MNCs required rate of return cannot be the same across the boarder. This implies that there are different in inherent risks for the firm for each country and as such the required return is calculated for specific projects being undertaken by an MNC.
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THE COST OF EQUITY CAPITAL The cost of equity capital is the required rate of return needed to motivate the investors to buy the firms stock. Calculation of the cost of equity is a different process and needs more approximations than calculating the cost of debt. For established firms, the dividend growth model may be used for computing the cost of equity. This model is also called the Gordon Model. Kc = D1/P0 + g Where, Kc Is the cost of equity capital D1 are dividends imparted in year one. P0 is the current market price of firms stock g is the compounded annual rate of growth in dividends or earnings. Alternatively, the cost of equity capital may be calculated by using the modern capital market theory. Accordingly to this theory, an equilibrium relationship exists between an assets required rate of return and its associated risk which can be calculated by the capital asset pricing model ( CAPM). The cost of equity may be calculated by the CAPM by using the following formula. E(R)j = Rf + Bj [ E(R)m Rf ] Where, E(R)j = the rate of return rate of return on a risk free assets measured by the current rate of return or yield on treasury bonds. E(R)m = is the expected rate of return on a broad market index such as the standard and index of industrial stocks. Bj = is the beta of stock j, measured by the relative volatility of the rate of return volatility of rate of return on the stock compared to the variability of the return on a broad market index. A beta of 1 (unit) denotes a risk equivalent to the one entered in an investment in a diversified portfolio of stocks.

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Figure below shows the capital assets pricing model Security Market Line E(R)j)

E(R)m)

Rf 1.0 1

Both the Gordon model and the CAPM, yield a risk adjusted rate of return on equity. The major difference is that the latter utilizes beta which is a measure of the market related or systematic risk rather than total risk which is traditionally measured by the standard derivation. Both methods yield acceptable and conceptually defensible estimates of the rate required by the investors given the degree of risk inherent in the investment. For firms with no established track record and for which beta coefficients are not available, the cost of equity may derived by adding an arbitrary risk premium to the firms recent borrowing rate. COMPUTING THE WEIGHTED COST OF CAPITAL

A Firms weighted cost of capital is a composite of the individual costs of financing weighted by the percentage of financing provided by each source. Therefore, a firms weighted cost of capital is a function of individual cost of capital, the make up of the capital structure i.e. the percentage of funds provided by debt, preferred stock and common stock. Thus, when a firm has both debt and equity in its capital structure, its financing cost can be represented by the weighted average cost of capital. This can be computed by weighting the after tax borrowing cost of the firm and the cost of equity capital structure i.e. the percentage of funds provided by debt, preferred stock and common stock. Thus, when a firm has both debt and equity in its capital structure, its financing cost can be represented by the weighted average cost of capital. This can be completed by weighting the after tax borrowing cost of the firm and the cost of equity capital using debt ratio as the weight.
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Specially

K= (1-Wd) Ke + Wd (1-T) i

Where K is weighted average cost of capital Ke is the cost of equity capital i is before tax borrowing cost. T is the corporate marginal tax rate and Wd is debt to total market value ratio. In general both Ke and i increase as the proportion of debt in the firms capital structure increases. At the optimal combination of debt and equity financing. However the weighted average cost of capital (K) will be the lowest. The firms cost of capital can also be measured as the weighted average cost of individual sources of long term financing. Specially K0 = Wd Kd (i-t)+ WP WP + We Re Where Re refers to the relative share of equity capital to the total long term funds of the organization. WP Refers to the weighted preference share capital Wd Refers to the weighted cost of debt and Ke, KP and Kd Refers to the cost of equity, preference and debt specifically. The weights used to calculated the relative proportions of Wd, WP and We could be based on book value or market value. Generally, market value weights are considered to be more superior to the book value weights as they request the current market scenario.

Ques 5:- Enumerate the various problem and issues in foreign investment analysis.. Ans 5:- Multinational capital budgeting is an increasingly vital area in the foreign operations of MNCs. The fundamental goal of the financial manager is to maximize shareholders wealth. Shareholders wealth is maximized when the firm, out of a list of prospectus investments, selects a combination of those projects that maximize the companies value to its shareholders.

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Capital budgeting for the MNCs uses the same framework as domestic capital budgeting. However, multinational firms engaged in evaluating foreign projects face a number of complications many of which are not there in the domestic capital budgeting process. Problem and Issue in Foreign Investment Analysis Foreign Exchange Risk:-

Multinational firms investing abroad are exposed to foreign exchange risk. The risk that the currency will appreciate or depreciate over a period of time. Understanding of foreign exchange risk is important in the evaluation of cash flow generated by the project over its life cycle. To incorporate the foreign exchange risk is the cash flow estimates of the project, the host country during the life span of the project. The cash flow, in terms of local currency, are then adjusted upwards for the inflation factor. Then the cash flows are converted into the parents currency at the spot exchange rate multiplied by an expected depreciation or appreciation rate calculated on the basis of purchasing power parity. In certain specific situations, the conversion can also be made on the basis of some exchange rate accepted by the management. Remittance Restrictions:

Where there are restrictions on the repatriation of income, substantial differences exist between project cash flows and cash flow received by the parent firm. Only those flows that are remittable to the parent are relevant from the MNCs perspective. Many countries impose a variety of restrictions on transfer of profits depreciation and other fees accruing to the parent company. Project cash flows consist of profits and depreciation charges whereas parents cash flows consist of the amounts that can be legally transfer by the affiliate. In cases where the remittances are legally limited, the restrictions can be circumvented to some extend by using techniques like internal transfer prices, overhead payments, and so on. To obtain a conservative estimate of the contribution by the project, the financial manager can include only the income which is remittable via legal and open channels. If this value is positive no more additions are made. If it is negative, we can add income that is remittable via other methods not necessary legal. Another adjustment in multinational capital budgeting is the problem of Blocked funds. Accounting for blocked funds in the capital budgeting process depends on the opportunity cost of blocked funds. If the blocked funds can be utilized in a foreign investment, the project cost to the investors may be below the local project construction cost. Also, if the opportunity cost
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of the blocked funds is zero the entire amount released for the project should be considered as a reduction in the initial investment. The Tax Issue:Both in domestic & multinational capital budgeting, only after tax cash flows are relevant for project evaluation. However, in multinational capital budgeting, the tax issue is complicated by the existence of the taxing jurisdiction, plus a number of other factors. The other factors include the form of remittance to the parent, dividends management, fees, royalties etc. tax withholding provisions in the host country, existence of tax treaties, etc. in addition, tax laws in many host countries discriminate between transfer of realized projects as against local reinvestment of these profits. The ability of the management firm to reduce its overall tax burden through the transfer pricing mechanism should also be considered. To calculate the actual after-tax cash flow accruing to the parent the higher of the home or host country tax rate can be used. This will represent a conservative scenario in the sense that if the project proves acceptable under this alternative then it will necessarily be acceptable under the more favorable tax scenario. If not, other tax saving may be incorporated in the calculation to determine whether or not the project crosses the hurdle rate.

Ques 6:-

Briefly explain the various techniques to assess country risk?

Ans 6:- Country risk is an indispensable tool for asset management as it requires the assessment of economic opportunity against political odds. A firm should incorporate the country risk assessment in its decision of whether to continue (or begin) investment in a particular country or not. Also, the country risk needs to be monitored continuously, since if risk becomes too high, the MNC will have to divest its subsidiaries in that country. Techniques it assess country risk The techniques to assess country risk mainly try and identify certain key economic political, and financial variables including a countrys economic growth rate, its current account balance relative to gross domestic products and various ratios-debt to GDP, debt service payments to GDP, saving to investments etc. some of the more popular indicators to assess country risk are: Page : 13/25

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A)

Debt Related Factors:-

The debt related factors are the quickest variables employed test the possibility of a country defaulting due to debt. To predict the risk of default, there are two different theoretical approaches. One approach regards default as arising out of an unintended deterioration in the borrowing countrys capacity to service its debt. The other approach views the probability of default of external debt as an international decision made by the borrower based on an assessment of the costs and benefits to rescheduling. Difficulties in debt servicing could be a result of short term liquidity problems or could be a result of short term liquidity problems or could be attributed to long term solvency problems. For example, countries with a high export growth rate are more likely to be able to service their debt and are expected to enjoy better creditworthiness rating since exports are the main source of foreign exchange earnings for most countries. Thus, lower export earnings are likely to increase the likelihood of short term liquidity problems and hence difficulties with debt serving. Similarly, a decline in the growth of output could contribute to long term insolvency problem and lower the countrys credit rating. The debt service indicators include:B) Debt/GDP Debt/foreign exchange receipts Short term debts/total exports Debt service ratio. Interest payments/Foreign exchange receipts Current account balance on GNP.

Balance of payments: The fundamental determinate of a countrys vulnerability is its balance of payment. The balance of payment management is a function of among other things, internal goals and changing external circumstances. A useful indicator of country risk analysis is the current account balance. It summarizes the countrys total transactions with the rest of the world for goods and services and represents the difference between national income and expenditure. It also indicates the rate at which a country is building foreign assets.

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The BOP on current account is negatively related to the probability of default since the current account deficit broadly equals the amount of new financing required. Countries with large current account deficits are thus less creditworthy. The balance of payments indicators include:C) Foreign income elasticity of demand for the exports Imports of goods and services/GDP Effective exchange rate index Non essential consumer goods and services/ total imports External reserves/imports Reserves as % of imports Economic Performance: -

Economic performance can be measured in terms of countrys rate of growth and its rate of inflation. The inflation rate can be regarded as a proxy for the quality of economic management. Thus higher the inflation rate, lower the credit worthiness rating. The economic performance can be measured by a set of ratios that focus on the long term growth prospects and any economic imbalances of that country. The significant ratios that can be used to measure economic performance are:GNP per capita Gross investment/gross Domestic product Inflation (Change in consumer prices as an average in %. This measures the quality of economic policy) D) Money supply (serves as an early indicator for future inflation) Gross Domestic savings/Gross National Product Political Instability:-

There have been several occasions when sovereign borrowers with the capacity to service their external debts have defaulted for purely political reasons. Political instability undermines the economic capacity of a country to service its debt. Political instability has both direct and indirect effect on the credit rating of a country.
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Political instability has an indirect effect on debt serving difficulties within a country and reduces a countrys willingness to service debt. Indirectly, political instability generates adverse consequences for economic growth, inflation, and domestic supply level of import dependency and creates foreign exchange shortage from an imbalance between the exports and imports. The direct effect of political instability on debt service problems emerge in the form of an unwillingness rather than an inability to service the debt. The political instability indicates which can be considered are:The political protest, for example protest demonstration, political strikes, riots etc. Successful and unsuccessful irregular transfer eg. Coup attempt etc. Checklist approach:-

E)

A number of relevant indicators that contribute to a firms assessment of a country risk are chosen and a weight is attached to each. All aspects of risk are summarized in a single country rating that can be readily integrated into the decision making process. Factors having greater influence on country risk are assigned greater weights. The weighted checklist approach employs a combination of statistical and judgmental factors. Statistical factors try and assess the performance of a countrys economy in the recent past in the expectation that this will provide an insight into the future. These factors can be complied earlier. The analyst can choose from a wide range of statistical factors- rapid rise in production costs, real GDP growth, debt/GDP, import GDP. The induction of judgmental factors gives some indication of a countrys future ability and willingness to repay. Factors in this category includes exchange rate management, political stability, balance of payments problems.

Ques 7:-

Write a detailed note on European Monetary System (EMS)?

Ans 7:- European countries were concerned about the negative impact of volatile exchange rates on their respective economies since the collapse of the Bretton Woods Agreement on fixed exchange rates in the early 1970s. Attempts were made to salvage the Bretton Woods system by defining the parties and widening the bonds of variations to
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2.25%. This was the Smithsoman Agreement, which was signed in December 1971 and was also known as the snake. The Snake was designed to keep the European Economic Community countries exchange rates within a narrower bond of 1.125% for their currencies. Thus this system allowed a wider bond of 2.25% against the currencies of other countries while maintaining a narrower bond of 1.125% for their currencies. The Snake get its name from the way EEC currencies moved together closely within the wider bond allowed for other currencies like the dollar. The Snake was adopted by the EEC countries because they felt that stable exchange rates among the EEC countries was essential for deepening economic integration and promoting intra EEC trade. However the snake agreement was replaced by the European Monetary system in 1979 and has since then undergone a number of major changes including major crisis and reorganization in 1992 and 1993. The chief objective of the EMS are:To form a zone of monetary stability in Europe To coordinate the exchange rate policies vis-a vis the non EMS currencies. To help in the eventual formation of a European Monetary. The EMS has three components.: i) ii) iii) i) Exchange Rate Mechanism (ERM) European Currency Unit (ECU) European Monetary Cooperation fund (EMCF) Exchange Rate Mechanism (ERM)

It refers to the producer by which the EMS member countries collectively manage their exchange rates. The ERM is based on a parity grid mechanism that places an upper and lower limit on the possible exchange rates between each pair of member currencies . in a parity grid mechanism each country is obliged to intervene whenever its exchange rate reaches the upper or lower limit against any other currency. The parity grid system, in the ERM, is in the form of a matrix showing for each pair of currencies the par value in addition to the highest and earnest permitted exchange rates. Each currency is then allowed to fluctuate 2 percent above and below the par rates. Each currency has hence got three exchange rates:a) The par value , b) an upper limit and c) a lower limit. The ERM has, thus got three features:Page : 17/25

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1) 2) 3)

A bilateral responsibility for the maintenance of exchange rates. Availability of additional support mechanism that helps in maintaining the parities. If the currencies irretrievably diverge from parity a last resort or safety value of agreed upon realignments. European Currency Unit:-

ii)

The ECU is a basket currency based on a weighted average of the currencies of member countries of the European Unit. The weights are based on each countrys relative size of GNP and on each members share of intra-European Union trade. The ECUs Value varies over time as the member currencies float jointly with respect to the US dollar and other non-member currency. The ECU serves as the accounting unit of the EMS and helps in the working of the exchange rate mechanism. Infect the ECU since Jan1999 has evolved into the common currency of the European Union and is called the Euro. The kinds of mechanism were energized in the EMS. One mechanism was based on the parity grid while the other was in terms of a divergence indicator defined with reference to the ECU.

Ques 8:- Write short note on World Bank and International Monetary Fund. Ans 8:- At the Bretton woods conference in 1944, it was decided to establish a new monetary order that would expand inter national trade, promote international capital flows and contribute to monetary stability. The IMF and the World Bank were born out of this conference at the end of World War II. The World Bank was established to help the restoration of economies disrupted by War by facilitating the investment of capital for productive purposes and to promote the long range balanced growth of international trade. On the other had, IMF is primarily a supervisory institution for coordinating the efforts of member countries to achieve greater cooperation in the formulation of economic policies. It helps to promote exchange stability and orderly exchange relations among its member countries. The World Bank
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The World Bank group is multinational financial institution established at the end of World War II to help provide long term capital for the reconstruction and the development of member countries. The group is important to MNCs because it provides much of the planning and financing for economic development projects involving billions of dollars for which private business can act as contractors and suppliers of goods and engineering related services. The purpose for the setting up the bank are:To assist in the reconstruction and development of territories of members by facilitating the investment of capital for production purposes, including the restoration of economies destroyed or disrupted by War. To promote the long-range balanced growth of international trade and the maintenance of equilibrium in the balance of payments by encouraging international investment for the development of the productive resources of members, thereby assisting in raising productivity, the standard of living etc. To arrange the loans made or guaranteed by it in relation to international loans through other channels so that the more useful and urgent projects, large & small alike, can be dealt with first. To conduct its operations with due regard to the effect of international investment on business conditions in the territories of member. The World Bank is the International Bank for reconstruction and Development (IBRD) and the International Development Association (IDA). The IBRD has two affiliates, the International Finance Corporation and the Multilateral Investment Guarantee Agency. The Bank, IFC and MIGA are sometimes referred to as the World Bank Group. The World Bank is the worlds largest source of development assistance. The bank uses its financial resources, its highly trained staff and its extensive knowledge base to individually help each developing country. The main focus is on helping the poor people and the poorest countries but for its clients, the Bank emphasis the need for investing in people, particularly through basic health and education, protecting the environment, strengthening the ability of the governments to deliver quality services efficiently, promoting reforms to create a stable macroeconomic environment conducive
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International Financial Management (FM-406) Contact: 92533-50008, 94164-43238

to investment and long term planning, focusing on social development inclusion, governance and institution building as key elements of poverty reduction. The bank is also helping countries to strengthen and sustain the fundamental conditions that help to attract and retain private investment. INTERNATIONAL MONETARY FUND The International Monetary Fund (IMF) came into official existence on December 27,1945 when 29 countries signed its Article of Association agreed at a conference held in Bretton Woods, USA from July 1-22, 1944. the IMF commenced financial operation on March 1. 1947. Its current membership is 182 countries. IMF is a cooperative institution that 182 countries have voluntarily joined because they see the advantage of consulting with one another on this forum to maintain a stable system of buying and selling their currencies so that payments in foreign currency can take place between countries smoothly and without delay. Its policies and activities are guided by its charter known as the Articles of Agreements. IMF lends money to members having trouble meeting financial obligations to other members, but only on the condition that they undertake economic reforms to eliminate these difficulties for their own goods and that of the entire membership. On Joining the IMF, each member country contributes a certain sum of money called a quota subscription as a sort of credit union deposit. Quotas serve various purposes. They form a pool of money that the IMF can draw from to lend to members in times of the financial difficulties. They form the basis of determining the special Drawing Rights (DWR) They determine the voting power of the members. Statutory purposes. The purposes of the IMF are:To promote international monetary cooperation through a permanent institution which provides the machinery for consultation on international monetary problems. To promote exchange stability, to maintain orderly exchange arrangements among members and to avoid competitive exchange depreciation.
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International Financial Management (FM-406) Contact: 92533-50008, 94164-43238

Ques 9:-

Write a short note on GATT?

Ans 9:- The General Agreement on Tariff and Trade during World War II, the world economy was badly shattered. Immediately after the war ended, the reconstruction of the world economy and the restoration of trade, which had virtually stopped during the war, become of permanent global concern. The many import restrictions instituted during the great depression of the 1930s continued to be a major stumbling block in promoting trade. GATT was founded to alleviate this problem. GATT was negotiated in 1947 and went into effect in January 1948. the twenty three countries that originally singed it were engaged at the time in drawing up the charter for a proposed international trade organization (ITO) which would have been a United Nations special agency. GATT based largely on select parts of the draft ITO charter, was concluded quickly in order to speed trade liberalization. It was expected that ITO would soon assume responsibility. However, plans for ITO were abandoned when it become clear that its charter would never be rectified and GATT becomes the only international instrument of trade rules accepted by the worlds major trade nations. Only international instrument of trade rules accepted by the worlds major trade nations. Today GATT is a multilateral treaty subscribed to by ninety governments which together account for more than four-fifths of world trade, GATTs rules govern the trade of its member countries and the conduct of their trade relations with one another. The contractual rights and obligations that it embodies have been accepted voluntarily in the mutual interest of its member countries. Overseeing the application of these rules is an important and continuing part of GATTs . actually GATT is also a means whereby countries negotiate and work together for the reduction of trade barriers in pursuit of the constant and fundamental aim of further liberalization of word trade. In successive multilateral negotiation through GATT, obstacles to trade have been progressively reduced. Since GATT has been in force, its activities have evolved in response to major changes in the world economic scene. These changes have included shifts in the relative economic strength of important countries or group of countries, the emergence of the developing third world as a major force in international affairs, the towards regional or preferential economic groups, new monetary and payments difficulties, and the growing participation of Eastern European Countries in GATT. These changes have emphasized GATTs role as a forum where such developments can be discussed and disputes resolved so that their undesirable effects can be countered through continuing efforts toward further liberalization of world trade.
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International Financial Management (FM-406) Contact: 92533-50008, 94164-43238

Ques 10:- Write a brief note on Taxation for multinational firms. Ans 10:- The yield of tax planning for multinational operations is an extremely complex but vitally important aspect of international business. The basic purpose of the multinational tax planning to minimize the firms worldwide tax burden. Double Taxation Avoidance Agreements Double taxation relief: Double taxation means taxation of some income of a person in more than one country. This results due to countries following different rules for income taxation. There are two main rules of income taxation (a) source of income rule and (b) residence rule. As per source of income rule, the income may be subject to tax in the country where the source of such income exist whether the income earner is a resident of such country or not. On the other hand income earner may be taxed on the basis of his residential status in that country. e.g. if a person is resident of a country, he may have to pay tax of any income earned outside that country as well. Further some countries may follow a mixture of the above two rules. Thus the problem of double taxation arises if a person is taxed in respect of any income on the basis of source of income rule in one country and on the basis of residence in another country or on the basis of mixture of above two rules. Relief against such hardship can be provided mainly in two ways:- (a) Bilateral relief (b) Unilateral relief. (a) Bilateral Relief The governments of the two countries can enter into agreement of provide relief against double taxations worked out on the basis of mutual agreement between the two concerned sovereign states. This may be called a scheme of bilateral relief as both concerned powers agree as to the basis of the relief to be granted by either of them. Agreement for bilateral relief may be of following two kinds:Agreement where two countries agree that income from various specified sources, which are likely to be taxed in both the countries, should either be taxed in only one of them or that each of the two countries should tax only a particular specified portion of the income so that there is no overlapping. Such an agreement will result in a complete avoidance of
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International Financial Management (FM-406) Contact: 92533-50008, 94164-43238

double taxation of the same income in the two countries. This is known as the exemption method of relief. The agreement that does not envisage any such scheme of single taxability but merely provides that, if any item of income is taxed in both the countries, the assesses should get relief in a particular manner. Under this type of agreement, the assesse is liable to have his income taxed in both the countries but is given a deduction, from the tax payable by him in India, of a part of taxes paid by him thereon, usually the lower of the two taxes paid. This is known as tax credit method of relief. Bilateral agreements ensure that either country is to reform from taxing the whole or part of the income only if the other country has kept to its part of the bargain. The relief under either of these types of agreements depends on an agreement between the countries concerned. b) Unilateral relief:

The above procedure for granting relief will not be sufficient to meet all cases. No country will be in a position to arrive at such agreement as envisaged above with al the country of the world fro all time. The hardship of the taxpayer, however, is a crippling one in all such cases. Some relief can be provided even in such cases by home country irrespective of whether the other country concerned has any agreement with India or has otherwise provided for any relief at all in respect of such double taxation. This relief is known as unilateral relief. Double Taxation Relief Provisions in India. In India the relief against the double taxation is provided under section 90 dn 91 of the Income Tax Act. Where there is agreement with Foreign Countries [Bilateral Relief] [Section 90] The Central Government may enter into an agreement with the government of any country outside India to provide for the following: A relief in respect of income on which both Income tax under this Act and income-tax in that country have been paid.

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The type of income, which shall be chargeable to tax in either country so that there is avoidance of double taxation of income under this Act and under the corresponding law in force in that country.

In addition the central Government may enter into an agreement to provide:For exchange of information for the prevention of avoidance of income tax chargeable under this Act or under the corresponding law in force in that country. For recovery of income tax under this act and under the corresponding law in force in that country.

Countries with which NO agreement exists [Unilateral Relief] [Section 91] If any person who is resident in India in any previous years proves that, in respect of his income which accrued during the previous year, he has paid in any country with which there is no agreement U/s 90 for the relief or avoidance of double taxation, income tax, by deduction or otherwise, under the law enforce in that country, he shall be entitled to the deduction from the Indian income tax payable by him of a sum calculated on such doubly taxed income at the Indian rate of tax or the rate of tax of eh said country, whichever is the lower, or at the Indian rate of tax of both the rates are equal.

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