November 28, 2014

International Finance and Financial Management in Multinational Company

World trade has increased. Companies export a lot and import a lot. Apart from import and export, now multinational, or global, corporations are emerging which operates in an integrated fashion in a number of countries. Also, there are companies that are using number of factories in various countries which are supported by suppliers located in various countries and then different countries are served by different factories.

In managing finance in companies with international trade or multinational operations,  some additional factors need to be considered.  Five of these factors are listed and described here:

1. Different currency denominations. Cash flows occur in  various currencies.  Hence,
exchange rates must be included in all financial analyses.

2. Political risk. Nations are free to place constraints on the transfer or use of corporate resources, and they can change regulations and tax rules at any time. They can even expropriate assets within their boundaries. Therefore, political risks occur in many forms  and they must be addressed explicitly in any financial analysis.

3. Economic and legal ramifications. Each country has its own unique economic and legal systems, and these differences can cause significant problems in operations.  For example, differences in tax laws among countries can cause a given economic transaction to have strikingly different after-tax consequences depending on the country where the transaction occurs. Legal differences
make procedures that are required in one part of the company illegal in others. These differences also make it difficult for executives trained in one country to move easily to another.

4. Role of governments.  Frequently, in many countries, the terms under which companies compete, the actions that must be taken or avoided, and the terms of trade on various transactions are determined not in the marketplace, but by direct negotiation between host governments and multinational enterprises. This is essentially a political process, and it must be treated as such. Thus,
traditional financial models have to be recast to include political and other noneconomic aspects of the decision.

5. Language and cultural differences. Different countries have unique cultural heritages that shape values and influence the conduct of business. Multinational corporations find that matters such as defining the appropriate goals of the firm, attitudes toward risk, performance evaluation and compensation systems, interactions with employees, and the ability to curtail unprofitable
operations vary dramatically from one country to the next.

Those five factors complicate financial management and increase the risks that multinational firms face. However, the prospects for high expected returns make it worthwhile for firms to accept these risks and learn how to manage them.

International Monetary Terminology

1. An exchange rate is the price of one country’s currency in terms of another country’s currency. One U.S. dollar would buy 0.5046 British pound, 0.6340 euro, or 0.9919 Canadian dollar.

2. A spot exchange rate is the quoted price for a unit of foreign currency to be delivered “on the spot” or within a very short period of time.

3. A forward exchange rate is the quoted price for a unit of foreign currency to be
delivered at a specified date in the future say 3 months or 6 months.

4. A fixed exchange rate for a currency is set by the government and is allowed to
fluctuate only slightly (if at all) around the desired rate, which is called the par

5. A floating or flexible exchange rate is not regulated by the government, so
supply and demand in the market determine the currency’s value. The U.S.
dollar and the euro are examples of free-floating currencies.

6. Devaluation or revaluation of a currency is the technical term referring to the
decrease or increase in the stated par value of a currency whose value is

7. Depreciation or appreciation of a currency refers to a decrease or increase,
respectively, in the foreign exchange value of a floating currency. These
changes are caused by market forces rather than by governments.

Monetary Arrangements of Countries with respect to Exchange Rates

At the most basic level, currency regimes can be divided into two broad groups:
floating rates and fixed rates.  In the floating-rate category, two main subgroups are there.

1. Freely floating. Here the exchange rate is determined by the supply and demand
for the currency.

2. Managed floating. Here there is significant government intervention to manage
the exchange rate by manipulating the currency’s supply and demand.  Governments rarely reveal their target exchange rate levels when they use a managed-float regime because doing so would
make it too easy for currency speculators to profit.

Types of fixed-exchange-rate regimes include the following:

1. No local currency. The most extreme position is for the country to have no local
currency of its own, using another country’s currency as its legal tender (such
as the U.S. dollar in the Panama Canal Zone).

2. Currency board arrangement. Under a variation of the first subregime, a country
technically has its own currency but commits to exchange it for a specified
foreign money unit at a fixed exchange rate.

3. Fixed-peg arrangement. In a fixed-peg arrangement, the country locks, or
“pegs,” its currency to another currency or basket of currencies at a fixed
exchange rate. This allows the currency to vary only slightly from its desired
rate; and if it moves outside the specified limits (often set at 1% of the target
rate), its central bank intervenes to force the currency back within the limits.

Other variations have been used, and new ones are developed from time to time.

MBA Core Management Knowledge - One Year Revision Schedule

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