GLOBAL FINANCE – Lesson 2

INTERNATIONAL FINANCIAL MANAGEMENT

International Finance
International finance is a section of financial economics that deals with the macro-economic
relation between two countries and their monetary transactions. The concepts like interest rate,
exchange rate, FDI, FPI, and currency prevailing in the trade come under this type of finance.

• We live in a globalized world. Every country is dependent on another country by some

other means. Developed countries look for a cheap workforce from developing countries, and
developing countries look for services and products.

• When a trade happens between two countries, as in this case, many factors come into
the picture and have to be considered during the execution of the business so that no violation
of regulation happens. For any economy (that which comprises individuals, commercial entities,
and the government involved in the production, distribution, exchange, and consumption of
products and services in a society with these activities collectively helping a nation determine the
availability and allocation of scarce resources to fulfill the needs of its people). international
finance is a critical factor; the local government should accordingly execute the policies so that
the local players are not facing severe competition from the non-local players.

International Finance Examples

• The Bretton Woods system was suggested in 1944 as the first common negotiated
monetary order to facilitate financial transactions among two countries.
• In the Bretton Woods system, the member countries agreed to take care of their trade
transactions across the borders and settle the bill in dollar-denominated bills, which they could
exchange for the equivalent of gold.
• That was the reason for quoting these bills to be “As good as gold.” Every currency of the
member countries like Canada, EU, Australia, and Japan was pegged against the common
universal currency USD.
• The USA ended this in 1971. The conversion of US dollars to gold was unilaterally
terminated. With this, the US and other mixed currencies became floating currencies again.
• Trump’s policies to increase the duty on products from China are another classic real-time
example.

Scope of International Finance

• It is important in determining the exchange rates of the country. One can do this against
the commodity (used in manufacturing other products and services or as a store of value,
manufactured or grown by different global producers with little or no differentiation). or the
common currency.
• It plays a crucial role in investing in foreign debt (the practice of borrowing a tangible
item, primarily money by an individual, business, or government, from another person, financial
institution, or state with the one who accepts the funds referred to as the borrower or debtor,
while the one giving it as the lender or creditor; may be in the form of cash, mortgages, bonds,
notes, and personal or commercial or student or credit card loans) securities to have a clear idea
about the market.
• The transaction between countries can be significant in assessing the economic
conditions of the other country.
• One can use arbitrage in tax, risk, and price to market imperfections (characterized by
companies selling different products and services, as opposed to perfectly competitive markets
where homogeneous products are sold. to book good profits while transacting in international
trade.

Significance and Importance

In a growing world moving towards globalization, (the extension of trade, commerce and culture
of an economy across different nations). It allows economies to exchange domestic products,
services, technologies, ideas and other resources globally.

It facilitates developed nations to make foreign direct investments (FDIs) made by an individual
or an organization, into a business located in a foreign country. The host nation receives job
creation prospects, advanced technology, a higher standard of living, infrastructural
development, and overall economic growth. for utilizing cheaper resources of developing
countries. The process increases employment opportunities, productivity, living standards and
earnings of emerging economies.

• its importance is growing in magnitude. Every day, the transaction between two countries
for trade is scaling up with the supporting factors.
• It considers the world a single market instead of individual markets and carries out the
other procedures. For the same reason, the firms and corporations doing such research include
institutions like the International Monetary fund (IMF), International Finance Corp (IFC), and the
World Bank. Trade between two foreign countries is one factor in developing the local economy
and improving economies of scale (the cost advantage of ramping up production. When a
business scales up, production cost per unit comes down—the fixed and variable costs are spread
over more number of units).

Currency fluctuations, arbitrage, interest rate, and trade deficit are crucial in prevailing scenarios.

Arbitrage is an act of generating income from trading a certain currency, security, or commodity
in two different markets. The arbitrageurs reap a margin from the varying price of the same
commodity in two different exchanges or markets.It is a practice that takes advantage of market
inefficiency. The same commodity, currency, or asset is priced differently in two or more distinct
markets. It indirectly improves the markets by highlighting loopholes. But as soon as the market
makes those improvements, the profitability for the arbitrageurs terminates.

Trade deficit is a scenario where the total sum of goods and service imports is higher than a
country’s exports. It is the surplus outflow of domestic currency in foreign markets. The inflow of
foreign currency is much less. and other international macroeconomic factors.

Macroeconomic factors are events, or situations that affect the national economy on a broad
scale, such as population, income, unemployment, etc. For instance, it includes economic outputs,
investments, savings, and inflation rates. These parameters are monitored by the highly
professional teams governed by the government or other economists) are crucial in prevailing
scenarios.

International Finance vs Domestic Finance

1. When all the business and economic transactions (the events that occur with third parties
such as customers, vendors, etc,, having monetary value and having tangible economic value to
the company’s economy as well as impacting the financial position of the company). occur within
a domestic boundary of the country, it is said to be domestic finance. However, if the transactions
occur across international borders, it refers to international finance.
2. There is more than taxation; international finance’s cultural and economic environment
will be similar to domestic finance.
3. Currency rates and currency derivatives are usually involved in international finance.
Whereas in domestic finance, not many financial instruments (certain contracts or any document
that acts as financial assets such as debentures and bonds, receivables, cash deposits, bank
balances, swaps, cap, futures, shares, bills of exchange, forwards, FRA or forward rate agreement,
etc. to one organization and as a liability to another organization and these solely taken into use
for trading purposes) as such are used.
4. The stakeholders (anyone, including a person, group, organization, government, or any
other entity with a direct or indirect interest in its operations, actions, and outcomes. They can
be external or internal based on their relationship with the company that serves their interests)
in domestic finance are usually uniform with a similar culture, language, and beliefs. Still, we can
see diversity among stakeholders’ cultures, languages, and values in international finance.
5. There are numerous options to raise capital from international finance, so the challenge
will be high. Whereas in domestic finance, not many opportunities to raise money will be there.
Thus, resulting in fewer challenges.
6. The accounting standards need to be as per GAAP in terms of international finance,
whereas there is no need to maintain separate ones in domestic finance.

Benefits

• There is a range of options in international trade and finance to raise and manage the
capital for the business.
• The scope of growth for companies concentrating on international trade is significantly
higher than for companies that do not.
• Different currencies and more opportunities to manage the capital involved will improve
its financial performance.
• The competitiveness improves when international trade is enabled in such markets. That
is because the quality of goods and services will improve without much difference in price due to
competition.
• Revenue (a firm’s total earnings from primary business operations such as sale of goods
or services rendered. It is shown as a top-line item in the income statement and is often referred
to as gross sales) from international trade can protect the company and not worry about
domestic demand as they still need overseas.
• The company has operations in more than one country and can act swiftly in emergencies
and conduct BCP (Business Continuity Protocol).

Disadvantages

• In political turmoil in one country, a stakeholder of international trade (the exchange of

goods and services across international borders. It usually comes with additional risks caused by
changes in exchange rates, government policies, laws, judicial systems, and financial markets)
affect the other stakeholders of the same business.
• Depending on other countries’ exchange rates is always risky, given that all currencies
have significant volatility (the rate of fluctuations in the trading price of securities for a specific
return. It is the shift of asset prices between a higher value and a lower value over a specific
trading period. When changes are big, and they occur frequently, the market is more volatile).
• One should carefully manage the credit risk (the probability of a borrower defaulting on
debt obligations. Lenders risk not receiving the principal and interest component of the debt.
This can result in an interrupted cash flow and increased cost of collection) because of
international trade. Otherwise, it can hamper profitability to a greater extent.
• It requires the disclosure of sensitive data more than domestic finance; the chance of
stolen confidential information is more in global markets.
• Local players cannot compete with big global players who are resource and research-
backed to develop quality products and services.
• As more than one culture is involved, cultural differences can damage the brand’s
reputation if not tackled properly.

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