Master of Business Administration – MBA Semester 4-SMU

MF0006 – International Financial Management

Assignment Set-1 & Set-2

Submitted by : Anuj Kumar

Reg No : 520926567
LC Code :1822
Date of Submission :22-11-2010
 Masters in Business Administration-MBA Semester IV
MF0006 – International Financial Management
Assignment Set-1

Note: Each question carries 10 Marks. Answer all the questions.

Q.1 Give possible reasons by which the companies are encouraged to be an MNC? [10
Marks]

A multinational corporation (MNC) trans national co-operation.(TNC), also called multinational

enterprise (MNE),[1] is a corporation or an enterprise that manages production or delivers
services in more than one country. It can also be referred to as an international corporation. The
International Labour Organization (ILO) has defined[citation needed] an MNC as a corporation
that has its management headquarters in one country, known as the home country, and operates
in several other countries, known as host countries.

International power:

Tax competition
Multinational corporations have played an important role in globalization. Countries and
sometimes subnationa regions must compete against one another for the establishment of MNC
facilities, and the subsequent tax revenue, employment, and economic activity. To compete,
countries and regional political districts sometimes offer incentives to MNCs such as tax breaks,
pledges of governmental assistance or improved infrastructure, or lax environmental and labor
standards enforcement. This process of becoming more attractive to foreign investment can be
characterized as a race to the bottom, a push towards greater autonomy for corporate bodies, or
both.

Market withdrawal
Because of their size, multinationals can have a significant impact on government policy,
primarily through the threat of market withdrawal.[11] For example, in an effort to reduce health
care costs, some countries have tried to force pharmaceutical companies to license their patented
drugs to local competitors for a very low fee, thereby artificially lowering the price. When faced
with that threat, multinational pharmaceutical firms have simply withdrawn from the market,
which often leads to limited availability of advanced drugs. In these cases, governments have
been forced to back down from their efforts.

Patents
Many multinational corporations hold patents to prevent competitors from arising. For example,
Adidas holds patents on shoe designs, Siemens A.G. holds many patents on equipment and
infrastructure and Microsoft benefits from software patents.[13] The pharmaceutical companies
lobby international agreements to enforce patent laws on others.

Government power
In addition to efforts by multinational corporations to affect governments, there is much
government action intended to affect corporate behavior. The threat of nationalization (forcing a
company to sell its local assets to the government or to other local nationals) or changes in local
business laws and regulations can limit a multinational's power. These issues become of
increasing importance because of the emergence of MNCs in developing countries.

The list of multinational companies in India is ever-growing as a number of MNCs are coming
down to this country now and then. Following are some of the major multinational companies
operating their businesses in India:

British Petroleum
Vodafone
Ford Motors
LG
Samsung
Hyundai
Accenture
Reebok
Skoda Motors
ABN Amro Bank
Q.2 What do you mean by International Trade Flows? Also explain various factors
affecting international trade flows. [10 Marks]

Trade refers to the exchange of goods and services for money. Sen argues that exchange is a
human right, “the freedom to exchange words, goods, or gifts does not need defensive
justification...they are part of the way human beings in society live and interact with one
another" (1999: 8). International trade refers to "sales which cross juridical borders" (Sutcliffe
2001: 71). The control of trade has been, and continues to be, an important focus of state policy,
and a determinant of international inequality.

One way to understand the effect of international trade on a country's economy is to examine its
trade as a percent of Gross Domestic Product.

The structure of world trade

With the rise of a global trading system at the time of European colonial expansion, a 'colonial
division of labor' emerged in which developing countries exported primary products, agriculture
and minerals, while Europe and North America exported manufactured goods. The structure of
world trade has begun to change since World War II and particularly in the last three decades.
Important characteristics of current global trade patterns now include:

* 75 % of the world's exports are from developed countries, while only 25% are from developing
ones;
* developed countries export mainly manufactured goods: 83% of their total, 62% of all world
exports;
* developing countries also export more manufactured goods than primary products: 56% of
their total, 14% of world exports;
* more primary products are exported by developed countries than by developing countries: 14%
of world exports, compared with 11% (Sutcliffe 2001: 71-75; UNCTAD 1999a).

Changing fortunes of developed and developing countries

A country's share in the world export market represents one measure of its participation in the
world economy and its purchasing power of imports. Although most developing countries
increased their share of exports during the 1990s, the increase was highly uneven. The following
describes major changes in trade patterns:

* from 1950 to 1970: developed countries gained in the share of total world exports, and
developing countries lost;
* in the 1980s and 1990s: a group of developing countries in East Asia significantly increased
their manufactured exports, and this increased their share of the world trade
* Latin America's share fell substantially from 1950 through 1990, and then began to increase
slightly
* Exports from West Asia and North Africa fell since 1980, due to declining petroleum prices.
* There has been a historic decline in the exports of the Sub-Saharan continent. Its share of the
world total has dropped from over 3 per cent in 1950 to barely 1 per cent in 1996. This has been
largely due to the fact that Africa has not basically changed the products it exports, and that the
prices of these products have tended to fall. (Sutcliff 2001: 76).

One alternative to globalized free trade is the creation of trade blocs which can manage and
promote trade within geographic regions. Some developing countries that are skeptical of free
trade prefer to participate in regional trade blocs which offer some protection against larger and
more aggressive global trading partners.

Factors affecting international trade flows:

Inflation
A relative increase in a country’s inflation rate will decrease its current account, as imports
increase and exports decrease.
National Income
A relative increase in a country’s income level will decrease its current account, as imports
increase.

Government Restrictions
A government may reduce its country’s imports by imposing tariffs on imported goods, or by
enforcing a quota. Note that other countries may retaliate by imposing their own trade
restrictions.
Sometimes though, trade restrictions may be imposed on certain products for health and safety
reasons.

Exchange Rates
If a country’s currency begins to rise in value, its current account balance will decrease as
imports increase and exports decrease.
Note that the factors are interactive, such that their simultaneous influence on the balance of
trade is a complex one.
Q.3 (a) Define Swaps. Also explain various types of swaps.

In finance, a swap is a derivative in which counterparties exchange certain benefits of one party's
financial instrument for those of the other party's financial instrument. The benefits in question
depend on the type of financial instruments involved. For example, in the case of a swap
involving two bonds, the benefits in question can be the periodic interest (or coupon) payments
associated with the bonds. Specifically, the two counterparties agree to exchange one stream of
cash flows against another stream. These streams are called the legs of the swap. The swap
agreement defines the dates when the cash flows are to be paid and the way they are calculated.
[1] Usually at the time when the contract is initiated at least one of these series of cash flows is
determined by a random or uncertain variable such as an interest rate, foreign exchange rate,
equity price or commodity price.

The five generic types of swaps, in order of their quantitative importance, are: interest rate
swaps, currency swaps, credit swaps, commodity swaps and equity swaps. There are also many
other types.

Interest rate swaps:

The most common type of swap is a “plain Vanilla” interest rate swap. It is the exchange of a
fixed rate loan to a floating rate loan. The life of the swap can range from 2 years to over 15
years. The reason for this exchange is to take benefit from comparative advantage.

Currency swaps
Main article: Currency swap
A currency swap involves exchanging principal and fixed rate interest payments on a loan in one
currency for principal and fixed rate interest payments on an equal loan in another currency. Just
like interest rate swaps;the currency swaps also are motivated by comparative advantage.

Commodity swaps
Main article: Commodity swap
A commodity swap is an agreement whereby a floating (or market or spot) price is exchanged for
a fixed price over a specified period. The vast majority of commodity swaps involve crude oil.

Equity Swap
Main article: equity swap
An equity swap is a special type of total return swap, where the underlying asset is a stock, a
basket of stocks, or a stock index. Compared to actually owning the stock, in this case you do not
have to pay anything up front, but you do not have any voting or other rights that stock holders
do have.

Credit default swaps

Main article: Credit default swap
A credit default swap (CDS) is a swap contract in which the buyer of the CDS makes a series of
payments to the seller and, in exchange, receives a payoff if a credit instrument - typically a bond
or loan - goes into default (fails to pay). Less commonly, the credit event that triggers the payoff
can be a company undergoing restructuring, bankruptcy or even just having its credit rating
downgraded.

(b) Define foreign bonds with their salient features. [10 Marks]

A foreign bond (called Yankee bond in the US, Samurai bond in Japan, Bulldog bond in the UK)
is a bondissued in a country's national bond market by an issuer not domiciled in thatcountry
where those bonds are subsequently traded.

Regulatory authorities in the country where the bond is issued impose rules governing the
issuance of foreign bonds.
Issuers of foreign bonds include national governments and their subdivisions, corporations, and
supranationals (an entity that is formed by two or more central governments through
international treaties).
They can be denominated in any currency.
They can be publicly issued or privately placed.

Eurobonds have the following features:

* underwritten by an international syndicate.

* offered simultaneously to investors in a number of countries at issuance.
* issued outside the jurisdiction of any single country. Therefore, they are not registered through
a regulatory agency.
* in practice they are typically registered on a national stock exchange. Why? Some institutional
investors are prohibited from purchasing securities that are not registered on an exchange. The
registration is mainly intended to overcome such restrictions. However, most of the Eurobond
trading occurs in the over-the-counter market.
* Make coupon payments annually.
 Master of Business Administration (MBA) – Semester 4
MF0006 – International Financial Management – 2 Credits
Assignment Set- 2

Note: Each question carries 10 Marks. Answer all the questions.

Q.1 (a) Explain the responsibilities of IMF.

The IMF's fundamental mission is to help ensure stability in the international system. It does so
in three ways: keeping track of the global economy and the economies of member countries;
lending to countries with balance of payments difficulties; and giving practical help to members.

Surveillance
The IMF oversees the international monetary system and monitors the financial and economic
policies of its members. It keeps track of economic developments on a national, regional, and
global basis, consulting regularly with member countries and providing them with
macroeconomic and financial policy advice.

Technical Assistance
To assist mainly low- and middle-income countries in effectively managing their economies, the
IMF provides practical guidance and training on how to upgrade institutions, and design
appropriate macroeconomic, financial, and structural policies.

Lending
The IMF provides loans to countries that have trouble meeting their international payments and
cannot otherwise find sufficient financing on affordable terms. This financial assistance is
designed to help countries restore macroeconomic stability by rebuilding their international
reserves, stabilizing their currencies, and paying for imports—all necessary conditions for
relaunching growth. The IMF also provides concessional loans to low-income countries to help
them develop their economies and reduce poverty.

(b) Describe two types of exchange rates. [10 Marks]

The exchange rate regime is the way a country manages its currency in respect to foreign
currencies and the foreign exchange market.
The two types of exchange rates are:

Pegged float:
Here, the currency is pegged to some band or value, either fixed or periodically adjusted. Pegged
floats are:
Crawling bands: the rate is allowed to fluctuate in a band around a central value, which is
adjusted periodically. This is done at a preannounced rate or in a controlled way following
economic indicators.
Crawling pegs: Here, the rate itself is fixed, and adjusted as above.
Pegged with horizontal bands: The currency is allowed to fluctuate in a fixed band (bigger than
1%) around a central rate.

Fixed exchange rate:

Fixed rates are those that have direct convertibility towards another currency. In case of a
separate currency, also known as a currency board arrangement, the domestic currency is backed
one to one by foreign reserves. A pegged currency with very small bands (< 1%) and countries
that have adopted another country's currency and abandoned its own also fall under this category.
Q.2 Illustrate Political Exposure in Foreign Exchange Market? [10 Marks]

The foreign exchange market (forex, FX, or currency market) is a worldwide decentralized over-
the-counter financial market for the trading of currencies. Financial centers around the world
function as anchors of trading between a wide range of different types of buyers and sellers
around the clock, with the exception of weekends. The foreign exchange market determines the
relative values of different currencies.

The primary purpose of the foreign exchange market is to assist international trade and
investment, by allowing businesses to convert one currency to another currency. For example, it
permits a US business to import British goods and pay Pound Sterling, even though the
business's income is in US dollars. It also supports speculation, and facilitates the carry trade, in
which investors borrow low-yielding currencies and lend (invest in) high-yielding currencies,
and which (it has been claimed) may lead to loss of competitiveness in some countries.

In a typical foreign exchange transaction, a party purchases a quantity of one currency by paying
a quantity of another currency. The modern foreign exchange market began forming during the
1970s when countries gradually switched to floating exchange rates from the previous exchange
rate regime, which remained fixed as per the Bretton Woods system.

Internal, regional, and international political conditions and events can have a profound effect on
currency markets.
All exchange rates are susceptible to political instability and anticipations about the new ruling
party. Political upheaval and instability can have a negative impact on a nation's economy. For
example, destabilization of coalition governments in Pakistan and Thailand can negatively affect
the value of their currencies. Similarly, in a country experiencing financial difficulties, the rise of
a political faction that is perceived to be fiscally responsible can have the opposite effect. Also,
events in one country in a region may spur positive/negative interest in a neighboring country
and, in the process, affect its currency.
Q.3 Explain Trade deficits and Trade surplus in regard to Balance of Payments. [10
Marks]

A balance of payments (BOP) sheet is an accounting record of all monetary transactions between
a country and the rest of the world. These transactions include payments for the country's exports
and imports of goods, services, and financial capital, as well as financial transfers. The BOP
summarises international transactions for a specific period, usually a year, and is prepared in a
single currency, typically the domestic currency for the country concerned. Sources of funds for
a nation, such as exports or the receipts of loans and investments, are recorded as positive or
surplus items. Uses of funds, such as for imports or to invest in foreign countries, are recorded as
a negative or deficit item.

When all components of the BOP sheet are included it must balance – that is, it must sum to zero
– there can be no overall surplus or deficit. For example, if a country is importing more than it
exports, its trade balance will be in deficit, but the shortfall will have to be counter balanced in
other ways – such as by funds earned from its foreign investments, by running down reserves or
by receiving loans from other countries.

When exchange rates are fixed by a rigid gold standard, or when imbalances exist between
members of a currency union such as the Eurozone, the standard approach to correct imbalances
is by making changes to the domestic economy. To a large degree, the change is optional for the
surplus country, but compulsory for the deficit country. In the case of a gold standard, the
mechanism is largely automatic. When a country has a favourable trade balance, as a
consequence of selling more than it buys it will experience a net inflow of gold. The natural
effect of this will be to increase the money supply, which leads to inflation and an increase in
prices, which then tends to make its goods less competitive and so will decrease its trade surplus.
However the nation has the option of taking the gold out of economy (sterilising the inflationary
effect) thus building up a hoard of gold and retaining its favourable balance of payments. On the
other hand, if a country has an adverse BOP its will experience a net loss of gold, which will
automatically have a deflationary effect, unless it chooses to leave the gold standard. Prices will
be reduced, making its exports more competitive, and thus correcting the imbalance. While the
gold standard is generally considered to have been successful[34] up until 1914, correction by
deflation to the degree required by the large imbalances that arose after WWI proved painful,
with deflationary policies contributing to prolonged unemployment but not re-establishing
balance. Apart from the US most former members had left the gold standard by the mid 1930s.