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International Financial Management

Notes exchange rates. The present International Monetary System set up is characterised by a
mix of floating and managed exchange rate policies adopted by each nation keeping in
view its interests. In fact, this variability of exchange rates is widely regarded as the most
serious international financial problem facing corporate managers and policy makers.
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 have 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.
2. Political risk: Another risk that firms may encounter in international finance is political
risk. Political risk ranges from the risk of loss (or gain) from unforeseen government
actions or other events of a political character such as acts of terrorism to outright
expropriation of assets held by foreigners. MNCs must assess the political risk not only in
countries where it is currently doing business but also where it expects to establish
subsidiaries. The extreme form of political risk is when the sovereign country changes the
“rules of the game” and the affected parties have no alternatives open to them.

Example: In 1992, Enron Development Corporation, a subsidiary of a Houston based
energy company, signed a contract to build India’s longest power plant. Unfortunately, the
project got cancelled in 1995 by the politicians in Maharashtra who argued that India did not
require the power plant. The company had spent nearly $300 million on the project. The Enron
episode highlights the problems involved in enforcing contracts in foreign countries. Thus,
political risk associated with international operations is generally greater than that associated
with domestic operations and is generally more complicated.
3. Expanded opportunity 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.
4. Market imperfections: The final feature of international finance that distinguishes it from
domestic finance is that world markets today are highly imperfect. There are profound
differences among nations’ laws, tax systems, business practices and general cultural
environments. Imperfections in the world financial markets tend to restrict the extent to
which investors can diversify their portfolio. Though there are risks and costs in coping
with these market imperfections, they also offer managers of international firms abundant
opportunities.
Thus, the job of the manager of a 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.

1.3.1 International Business Activities

The volume of international business has exploded in recent years. Globalisation is the new
buzzword in industry circles today and is making economies to be more open and adaptable to
foreign investment. The inflow of foreign investment is very important for the economic
development of a country. The inflows from foreign investment can be divided into two
categories:
1. Foreign Direct Investments (FDI) are investments made for the purpose of actively
controlling property assets or companies located in host countries.

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