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Preface
This book comes at a time when we are grappling with the challenges of a global economic crisis, the ramifications of which are as severe as that of
the Great Depression of the 1930s. In a world where economies are increasingly integrated and open to cross-border trade and investments, we have
experienced the benefits of globalization, be it in small or large measure. And now, we are witness to the other side of globalization and can see how
fast the economic ills of one country can spread throughout the globe and affect people and institutions the world over. An overview of the
developments that led to this crisis and its aftermath will help us appreciate the integration of world economies.

Recent Developments in the Financial World

The subprime crisis in the United States and the subsequent collapse of several financial institutions, the increased volatility in foreign exchange
rates, and the bailout and stimulus measures adopted by the governments of various nations to control the crisis are some of the most important
developments in the global financial world in recent times.

The U.S. subpr ime cr isis

The present world economic turmoil can be traced back to the subprime lending crisis in one of the largest economies in the world, the United States.
Lending to those who don't qualify for the best market interest rates because of their deficient credit record is referred to as subprime lending. The
subprime lending debacle, which started in mid-2007 in the United States, has become a financial contagion and sent shock waves throughout the
world economy. Several financial institutions, such as Fannie Mae; Freddie Mac; Lehman Brothers; American International Group, Inc. (AIG); and
Washington Mutual in the United States, and Fortis, the DutchBelgian Bank; Dexia, the FrenchBelgian bank; Bradford & Bingley; Aegon; and Hypo
Real Estate in Europe, were declared bankrupt. Some, of course, were bailed out when they were on the verge of collapse. According to the United
Nations Conference for Trade and Development (UNCTAD), between September 2007 and October 2008,16 banks in the United States filed for
bankruptcy and more than 100 were on the watchlist of the Federal Reserve. In addition to this, stock markets, along with commodity prices,
collapsed. For instance, the Bombay Stock Exchange (BSE) Sensex reached its peak of 20,812.65 in January 2008, but rapidly came down to
8451.01the lowest in the yearin October 2008. The high volatility in stock prices as well as commodity prices has shattered the confidence of
market participants. The exports of several countries have been hit badly, which has further increased their current account deficits. The spread
between interbank interest rates and treasury bills has increased tremendously because of increasing interbank interest rates and decreasing yields
on treasury bills. In this scenario, banks have become extremely reluctant to participate in the interbank market as they have lost confidence in the
creditworthiness of counterparties. In view of their bad loans, particularly subprime mortgage loans, financial institutions including banks worldwide
had written down about USD 700 billion worth of assetbacked securities by the end of September 2008. This indicates that their capital base has
been eroded and, consequently, their capacity to lend has been reduced. The contagion effect of the crisis has also resulted in reversals in private
capital flows to developing economies. The cost of external borrowing has increased phenomenally. These developments will have farreaching
implications for the development of emerging economies.

Volatility in for eign exchange mar kets

The turbulence in global financial markets has also increased the volatility in foreign exchange markets. The U.S. dollar depreciated substantially
against other major currencies in the beginning of 2008, but subsequently reversed its direction in late 2008. Many currencies, including the
currencies of developing nations, have depreciated considerably against the U.S. dollar. For example, the exchange rate of the Indian rupee against
the U.S. dollar appreciated to 34.48 in March 2008 from 39.28 in January 2008. Large foreign capital inflows resulted in the appreciation of the Indian
rupee against the U.S. dollar. But, following this, the Indian rupee depreciated and recorded a historic low of 50.58 in October 2008, mainly because
of large outflows of foreign institutional investments. The Indian rupee's previous historic low was recorded in 2002, when it touched 49.07 against the
USD. As a result of the depreciation of major currencies against the U.S. dollar, current account imbalances across the world have narrowed. For
example, the current account deficit of the United States reduced to some extent in 2008. The official foreign exchange reserves of many countries
are expected to either stagnate or decline, as they are likely to experience a weakening of the current and/or capital accounts.

The need for adequate contr ol mechanisms

The global financial crisis is considered to be a systemic crisis because it has affected all financial institutions and markets and, moreover, has spread
to the real economy. The lack of an institutional mechanism along the lines of the World Trade Organization (WTO) to monitor and coordinate the
activities of financial institutions, including banks and financial markets, is a major shortcoming of the international financial system. Further, there is
no mechanism or institution that can integrate the functioning of the international trading system and the international financial system (including the
international monetary and fiscal system). Unfettered financial markets, including foreign exchange markets, have proved wanting in their selfregulatory capacity.
According to UNCTAD, most developed countries entered an economic recession during the latter part of 2008. The economic slowdown has also
gripped developing economies and economies in transition. The United Nations baseline forecast says that the world's gross product would come
down to just 1 per cent in 2009 as against the 2.5 per cent growth estimated for 2008. The income per capita for the world as a whole is expected to
decline in 2009. The per capita income growth in many nations will be negative, as compared to the robust growth registered during the period 2002

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2007. The report further states that it will take six to nine months for financial markets in developed countries to return to normalcy, provided certain
stimulus measures are introduced. The governments of many countries have now initiated both bailout and stimulus measures. For instance, the
Government of India, in its efforts to minimize the impact of the global economic slowdown, has announced a stimulus package, which includes a 4
per cent acrosstheboard cut in excise duty, a hike in public expenditure on infrastructure projects, and an increase in public expenditure by INR
1.47 lakh crore, which would be over and above the INR 7.5 lakh crore already provided in the budget for 200809. In September 2008, the Reserve
Bank of India (RBI) reduced the repo rate from 9 per cent to 6.5 per cent and the reverse repo rate from 6 per cent to 5 per cent. The cash reserve
ratio (CRR) was reduced from 9 per cent to 5.5 per cent. In the second stimulus package announced on 2 January 2009, the RBI further reduced the
repo and reverse repo rates by 100 basis points each, from 6.5 per cent to 5.5 per cent and from 5 per cent to 4 per cent. The repo rate is the rate at
which banks can borrow from the RBI, and the reverse repo rate is the rate at which banks can park their funds with the RBI. The second stimulus
package includes the reduction of CRR from 5.5 per cent to 5 per cent. The cash reserve ratio refers to the portion of deposits that banks have to
maintain with the RBI. A reduction in CRR infuses additional liquidity into the economy. Following the reduction of repo rates by the RBI, several
banks in India have announced lower lending and deposit rates.

Dealing with Corporate Finance from the I nternational Perspective

The phenomenal growth of international trade, cross-border investments, and the recent economic crisis have made it necessary for finance
managers and students of finance to understand the dynamics of financial decisions, especially those that involve foreign exchange rates and
markets. International Financial Management seeks to provide finance managers and students with the knowledge and skills required for managing
business operations in the international arena. The book also aims to help them take advantage of the opportunities available in the global
environment and, at the same time, protect their businesses from the vagaries of exchange rates. The framework of international finance will also be
useful for policymakers and executives in government and nongovernmental (notforprofit) organizations.
With its numerous solved examples, practice problems, and case studies and its focus on financial practices and policy, the book is designed to
help students who aspire to become finance managers, executives, financial analysts, or financial consultants to apply the concepts of international
finance to realworld events and situations. As the book provides the conceptual framework and analytical tools necessary to make financial
decisions from an international perspective, it is also suitable for executive development programmes and management development programmes.

Organization of the Book

This book is organized into 16 chapters. The topics in each chapter are discussed from the perspective of the finance manager in the international
context, with a special focus on India.
Chapter 1, The Foreign Exchange Market: Structure and Operations, discusses the structure and operations of the foreign exchange market and
introduces the reader to foreign exchange rates. This chapter acts as the foundation for the concepts dealt with in the following chapters.
Chapter 2, The International Monetary System, focuses on different exchange rate regimes in the world and their implications. The chapter also
highlights the developments in the exchange rate system of India.
Chapter 3, The Balance of Payments: Implications for Exchange Rates, deals with the balance of payments and discusses its impact on exchange
rates. Students of international finance usually find it difficult to understand how international transactions are recorded and what their implications for
exchange rates are. This chapter deals with these issues by providing various solved examples, and it also discusses the convertibility of currency
and its implications.
Chapter 4, International Parity, discusses various parity conditions such as purchasing power parity, interest rate parity, forward rate parity, and
the international Fisher effect. The basic concept of exchange rate determination leads the discussion on international parity.
Chapter 5, Management of Foreign Exchange Exposure and Risk, highlights different kinds of foreign exchange exposures and risks faced by
firms and discusses how such risks can be managed.
Chapter 6, Currency Forwards and Futures, Chapter 7, Currency Options, and Chapter 8, Financial Swaps, deal with derivatives. Chapter 6
highlights how the forward and futures markets operate and elaborates on the trading strategies associated with futures. The chapter also introduces
the concept of interest rate futures to readers. Chapter 7 explains various currency option trading strategies. Option pricing is the focus of this
chapter. A comparison of options, forwards, and futures provides an overview of the various currency derivatives. Chapter 8 discusses financial
swaps as riskmanagement tools and profitgenerating strategies.
The chapter focuses on interest rate swaps and currency swaps. The chapter also explains the concept of forward rate agreements.
Chapter 9, Crossborder Investment Decisions, deals with the evaluation of investment projects from an international perspective. The concept
of real options is also explained here.
Chapter 10, Financing Decisions of MNCs, provides insights into the financing decisions of multinational corporations. It explains how the cost of
capital and capital structure decisions of MNCs are different from those of domestic firms. It also discusses various methods of raising capital funds
for foreign projects.
Chapter 11, Management of Working Capital: An International Perspective, discusses the four major variables of working capitalcash,
receivables, inventory, and trade creditfrom the perspective of international working capital management.
Chapter 12, International Trade, begins with an introduction of the major theories of international trade and goes on to discuss various
developments in world trade. India's performance in international trade is a major highlight of this chapter.
Chapter 13, Foreign Investments, discusses foreign direct investments (FDIs) and foreign institutional investments (FIIs) at length. India's policy
towards FDIs and FIIs are also discussed in this chapter.
Chapter 14, Portfolio Theory in International Perspective, focuses on the capital asset pricing model (CAPM) from an international perspective.
The chapter also discusses the scope for reducing investment risk through international portfolio diversification.
Chapter 15, The Indian Accounting and Taxation System, discusses accounting and taxation systems at the international level and focuses on
India's accounting and taxation system. It also provides a glimpse of the treaties between India and its neighbouring countries for the avoidance of
double taxation.
Chapter 16, Multilateral Financial Institutions, is the final chapter in the book. It provides a brief overview of significant multilateral institutions such
as the World Bank, the International Monetary Fund (IMF), the Asian Development Bank (ADB), the International Development Association (IDA), and
the International Finance Corporation (IFC).

The Teaching and Learning Package

The teaching and learning package includes an instructors manual and PowerPoint lecture slides, which can be downloaded from
http://www.pearsoned.co.in/thummulurisiddaiah, the book's companion Web site.

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Instructors Manual: Chapter overviews and hints to relevant chapterend questions and problems are provided in the instructors manual.
PowerPoint Presentations: PowerPoint lecture slides are designed to provide an overview of the important concepts and equations discussed in each chapter.
Additional Material: In addition to the PowerPoint presentations and the instructors manual, the companion Web site can also be used to access data on additional
topics such as external commercial borrowings (ECBs), euro issues, and India's FDI policy. With rapid developments at the global level, some of the information
provided in this book, like all other books on contemporary issues, is bound to require revision despite our best efforts to provide current data. Readers can refer to
the companion Web site for updated information as such developments take place.

A Note on the Terms and the Currency System Used in this Book
The ISO 4217 code for currencies has been used in this book. So, readers will find that INR has been used in place of Rs, GBP in place of , USD in place of $,
and
JPY in place of . Table 1.1 in Chapter 1 provides a list of the major currencies in the world and their symbols and ISO 4217 codes.
As far as possible, million and billion have been used to represent large numbers in place of lakh and crore, which are commonly used in Indian books. However,
where the primary data was available in lakh and crore (most of the RBI data, for instance), the information has been retained in the original style. The following
table will help readers convert amounts in lakh/crore to amounts in million/billion in the same currency:

Amount in lakh/crore

Amount in figures

Amount in million/billion

1 lakh

100,000

100 thousand

10 lakh

1,000,000

1 million

1 crore

10,000,000

10 million

10 crore

100,000,000

100 million

100 crore

1,000,000,000

1 billion

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