1.0 INTRODUCTION TO INTERNATIONAL FINANCIAL MANAGEMENT

What is International Financial Management?

This is concerned with financial management in an international setting.

Financial management in general terms is mainly concerned with how to optimally make various corporate financial decisions, such as those pertaining to:-

 Investment;

 Capital structures;

 Dividend policy; and

 Working capital management.

All the above decisions are with the view to achieving a set of given corporate objectives.

We need international financial management because we are now turning in a highly globalize and integrated world. Continued liberalization of international trade is certain to further internationalize consumption patterns around the world. Like consumption, production of goods and services has become highly globalize. To a large extent, this has happened as a result of multinational corporations (MNCs) …. Efforts to source inputs and locate production anywhere in the world where costs are lower and profits are higher.

Recently, financial markets have also become highly integrated. This development allows investors to diversify their portfolios internationally. In the words of a wall street journal article, “Over the past decade, its investors have framed buckets of money into overseas markets, in the form of mutual funds. At the same time, Japanese investors are investing heavily in U.S and other foreign financial markets an effort to recycle enormous trade surpluses.

In addition, many major corporations of the world, such as IBM, Sony, etc, have the shares cross-listed on foreign stock exchange, thereby rendering their shares internationally tradable and gaining access to foreign capital as well.

Undoubtedly, we are now living in a world where all the major economic functions. Consumption, production and investment are highly globalised. It is thus essential for financial managers to fully understand vital international dimensions of financial management.

Dimensions about International Finance

This deals with: “How is international finance different from domestic finance”.

There are three major dimensions set for international finance a part from domestic finance. They are:-

1. Foreign exchange and political risk.

2. Market imperfection.

3. Expanded opportunity set.

These major dimensions of international finance largely stem from the fact that sovereign nations have the right and power to issue currencies, formulate their own economic policies, impose taxes and regulate movement of people, goods and capital across their borders.

1. Foreign Exchange and Political Risk

When firms and individuals are engaged in cross border transactions, they are potentially exposed to “foreign exchange risk” that they would not normally encounter in purely domestic transactions.

Currently, the exchange rates among such major currencies fluctuate continuously in an unpredictable manner. This has been the case since the early 1970s when fixed exchange rates were abandoned, exchange rate utility has exploded since 1973 and will have a persuasive influence in all major economic functions, that is, consumption, production and investment.

On the other hand, one of the major risks that face firms and individuals an international setting is “political risk”; and this ranges from unexpected changes in tax rules to outright expropriation of assets held by foreigners. Political risk arises from the fact that a sovereign country can change the “rules of the game” and the affected parties may not have effective recourse.

For example, in 1992, the Enron Development Corporation, a subsidiary of a Huston-based energy-based company, signed a contract to build India’s longest power plant. After Euron had spent nearly $300 million, the project was cancelled in 1995 by nationalist politicians in the Maharashtra State, who argued India did not need the power plant. This episode illustrates the difficulty of enforcing contracts with foreign committees.

2. Market Imperfections

Although the world economy is much more integrated today than was the case 20 years ago, a variety of barriers still hamper free movement of people, goods, services, and capital across national boundaries. These barriers include legal restrictions, excessive transaction and transportation costs, and discriminatory taxation. The world markets are thus highly imperfect. Market imperfections, which of present various functions and impediments preventing markets from functioning perfectly, play an important role in motivating MNCs to locate production overseas. For example, Honda, a Japanese automobile company, decided to establish production facilities in Ohio, Munich to circumvent trade barriers i.e. MNCs are always referred to be a gift of market imperfections.

Imperfections in the world financial market tend to restrict the extent to which investors can diversify their portfolio. For example, Nestle Company, a Swiss MNC, used to issue two different classes of common stock, bearer shares and registered shares and foreigners were allowed to hold only bearer shares. Bearer shares used to trade for about twice the price of registered shares, which were exclusively presented for Swiss residents. This kind of price disparity is a uniquely international phenomenon that is attributable to market imperfections.

3. Expanded Opportunity Set

When firms venture into the arena of global markets, they can benefit from “an Expanded Opportunity Set”. Firms can locate production in any country or region of the world to maximize their performance and raise funds in any capital market where the cost of capital is lowest. In addition, firms can gain from greater economies of scale when their tangible and intangible assets are deployed on a global basis.

Individual investors can also benefit greatly if they invest internationally rather than domestically. If you diversify internationally, the resulting international portfolio may have a lower risk or higher return (or both) than a purely domestic portfolio.

This can happen mainly because stock returns tend to carry much less across countries than within a given country. Once you are aware of overseas investment opportunities and are willing to diversify internationally, you face a much expanded opportunity set and you can benefit from it.

Goals for International Financial Management

International Financial Management is designed to provide today’s financial managers with an understanding of the fundamental concepts and tools necessary to be effective global managers. International financial management is geared to the realization of the goal of “shareholder wealth maximization”, which means that the firm makes all business decisions and investment with an eye towards making the owners of the firm – the shareholders better off financially, or more wealthy, than they were before.

GLOBALISATION OF THE WORLD ECONOMY: RECENT TRENDS

(i) Key Trends of the World Economy

The emergence of globalised financial markets. The 1990s saw the rapid integration of international capital and financial markets. The impetus for globalized financial markets initially came from the government of major countries that began to deregulate the foreign exchange and capital markets.

For example, in 1980, Japan deregulated its foreign exchange market; 1986, the Big Bang occurred when the London Stock Exchange eliminated brokerage commissions, etc.

Deregulated financial markets and heightened competition in financial services provided a national environment for financial innovation that resulted in the introduction of various instruments; e.g. currency futures and options, multi currency frauds, international mutual funds, country funds and foreign stock index futures and options.

Communications played an active role in integrating the world financial market listing their shares across boarders, and this allow investors to buy and sell foreign shares as if they were domestic shares, facilitating international investments.

Lastly, advances in computer and telecommunication technology contributed to the emergence of global...