International Financial Management

01/04/2020 0 By indiafreenotes

International Financial Management is a well-known term in today’s world and it is also known as international finance. It means financial management in an international business environment. It is different because of the different currency of different countries, dissimilar political situations, imperfect markets, diversified opportunity sets.

International Financial Management came into being when the countries of the world started opening their doors for each other. This phenomenon is well known by the name of “liberalization”. Due to the open environment and freedom to conduct business in any corner of the world, entrepreneurs started looking for opportunities even outside their country boundaries. The spark of liberalization was further aired by swift progression in telecommunications and transportation technologies that too with increased accessibility and daily dropping prices. Apart from everything else, we cannot forget the contribution of financial innovations such as currency derivatives; cross-border stock listings, multi-currency bonds and international mutual funds.

The resultant of liberalization and technology advancement is today’s dynamic international business environment. Financial management for a domestic business and an international business is as dramatically different as the opportunities in the two. The meaning and objective of financial management do not change in international financial management but the dimensions and dynamics change drastically.

Difference between International and Domestic Financial Management

Four major facets which differentiate international financial management from domestic financial management are an introduction of foreign currency, political risk and market imperfections and enhanced opportunity set.

  1. Foreign Exchange

It’s an additional risk which a finance manager is required to cater to under an International Financial Management setting. Foreign exchange risk refers to the risk of fluctuating prices of currency which has the potential to convert a profitable deal into a loss making one.

  1. Political Risks

Political risk may include any change in the economic environment of the country viz. Taxation Rules, Contract Act etc. It is pertaining to the government of a country which can anytime change the rules of the game in an unexpected manner.

  1. Market Imperfection

Having done a lot of integration in the world economy, it has got a lot of differences across the countries in terms of transportation cost, different tax rates, etc. Imperfect markets force a finance manager to strive for best opportunities across the countries.

  1. Enhanced Opportunity Set

By doing business in other than native countries, a business expands its chances of reaping fruits of different taste. Not only does it enhances the opportunity for the business but also diversifies the overall risk of a business.

Just like domestic financial management, the goal of International Finance is also to maximize the shareholder’s wealth. The goal is not only is limited to the ‘Shareholders’ but extends to all ‘Stakeholders’ viz. employees, suppliers, customers etc. No goal can be achieved without achieving welfare of shareholders. In other words, maximizing shareholder’s wealth would mean maximizing the price of the share. Here again comes a question, whether in which currency should the value of the share be maximized? This is an important decision to be taken by the management of the organization.

International level initiatives like General Agreement on Trade and Tariffs (GATT), The North American Free Trade Agreement (NAFTA), World Trade Organization (WHO) etc has to give promoted international trade and given it a shape. All because of liberalization and those international agreements, we have a buzz word called “MNC” i.e. Multinational Corporations. MNCs enjoy an edge over other normal companies because of its international setting and best opportunities.

International Finance has become an important wing for all big MNCs. Without the expertise in International Financial Management, it can be difficult to sustain in the market because international financial markets have a totally different shape and analytics compared to the domestic financial markets. A sound management of international finances can help an organization achieve same efficiency and effectiveness in all markets.

International finance analyzes the following specific areas of study:

  • The Mundell-Fleming Model, which studies the interaction between the goods market and the money market, is based on the assumption that price levels of said goods are fixed.
  • International Fisher Effect is an international finance theory that assumes nominal interest rates mirror fluctuations in the spot exchange rate between nations.
  • The optimum currency area theory states that certain geographical regions would maximize economic efficiency if the entire area adopted a single currency.
  • Purchasing power parity is the measurement of prices in different areas using a specific good or a specific set of goods to compare the absolute purchasing power between different currencies.
  • Interest rate parity describes an equilibrium state in which investors are indifferent to interest rates attached to bank deposits in two separate countries.

Example of International Institutions of International Finance

The Bretton Woods System

The Bretton Woods system was created at the Bretton Woods conference in 1944, where the 40 participating countries agreed to establish a fixed exchange rate system. The collective goal of this initiative was to standardize international monetary exchanges and policies in a broader effort to create post World War II stability.

The Bretton Woods conference catalyzed the development of international institutions that play a foundational role in the global economy. These include the International Monetary Fund (IMF), a consortium of 189 countries dedicated to creating global monetary cooperation, and the International Bank for Reconstruction and Development, which later became known as the World Bank.