MB0053 - International Business Management - Set 1

SIKKIM MANIPAL UNIVERSITY

DEPARTMENT OF DISTANCE EDUCATION

ASSIGNMENT

SEMESTER 4

NAME : ABHISHEK JAIN

ROLL NUMBER : 511035358

LEARNING CENTER : 02882

SUBJECT NAME :

INTERNATIONAL BUSINESS

MANAGEMENT (MB0053)

MODULE NO : SET 1

DATE OF SUBMISSION AT THE

LEARNING CENTRE : 31-MAY-11

FACULTY SIGNATURE :

MBA 4th Sem Assignment International Business Management – MB0053 – Set 1

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Master of Business Administration-MBA Semester 4

International Business Management – MB0053 Assignment Set - 1

Q.1 What is globalization? What are its benefits? How does globalization help in international

business? Give some instances?

Ans : Globalization (or globalisation) describes the process by which regional economies, societies,

and cultures have become integrated through a global network of political ideas through

communication, transportation, and trade. The term is most closely associated with the term

economic globalization: the integration of national economies into the international economy

through trade, foreign direct investment, capital flows, migration, the spread of technology, and

military presence. However, globalization is usually recognized as being driven by a combination of

economic, technological, sociocultural, political, and biological factors. The term can also refer to

the transnational circulation of ideas, languages, or popular culture through acculturation. An

aspect of the world which has gone through the process can be said to be globalized.

Against this view, an alternative approach stresses how globalization has actually decreased inter-

cultural contacts while increasing the possibility of international and intra-national conflict.[3]

Globalization has various aspects which affect the world in several different ways

Industrial - emergence of worldwide production markets and broader access to a range of

foreign products for consumers and companies. Particularly movement of material and

goods between and within national boundaries. International trade in manufactured goods

increased more than 100 times (from $95 billion to $12 trillion) in the 50 years since

1955.China's trade with Africa rose sevenfold during 2000-07 alone.

Financial - emergence of worldwide financial markets and better access to external

financing for borrowers. By the early part of the 21st century more than $1.5 trillion in national

currencies were traded daily to support the expanded levels of trade and investment

Economic - realization of a global common market, based on the freedom of exchange of

goods and capital

Job Market- competition in a global job market. In the past, the economic fate of workers

was tied to the fate of national economies. With the advent of the information age and

improvements in communication, this is no longer the case. Because workers compete in a

global market, wages are less dependent on the success or failure of individual economies.

This has had a major effect on wages and income distribution

Political - some use "globalization" to mean the creation of a world government which

regulates the relationships among governments and guarantees the rights arising from social

and economic globalization. Politically, the United States has enjoyed a position of power

among the world powers, in part because of its strong and wealthy economy. With the

influence of globalization and with the help of the United States’ own economy, the People's

Republic of China has experienced some tremendous growth within the past decade. If

China continues to grow at the rate projected by the trends, then it is very likely that in the

next twenty years, there will be a major reallocation of power among the world leaders.

China will have enough wealth, industry, and technology to rival the United States for the

position of leading world power.

Most of us assume that international and global business are the same and that any company that

deals with another country for its business is an international or global company. In fact, there is a

considerable difference between the two terms.

International companies – Companies that deal with foreign companies for their business are

considered as international companies. They can be exporters or importers who may not have any

investments in any other country, apart from their home country.

Global companies – Companies, which invest in other countries for business and also operate from

other countries, are considered as global companies. They have multiple manufacturing plants

across the globe, catering to multiple markets.

The transformation of a company from domestic to international is by entering just one market or a

few selected foreign markets as an exporter or importer. Competing on a truly global scale comes

later, after the company has established operations in several countries across continents and is

racing against rivals for global market leadership. Thus, there is a meaningful distinction between a

company that operates in few selected foreign countries and a company that operates and

http://en.wikipedia.org/wiki/Globalization#cite_note-2


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markets its products across several countries and continents with manufacturing capabilities in

several of these countries.

Companies can also be differentiated by the kind of competitive strategy they adopt while dealing

internationally. Multinational strategy and global competitive strategy are the two types of

competitive strategy.

Multinational strategy – Companies adopt this strategy when each country’s market needs to be

treated as self contained. It can be for the following reasons:

o Customers from different countries have different preferences and expectations about a

product or a service.

o Competition in each national market is essentially independent of competition in other

national markets, and the set of competitors also differ from country to country.

o A company’s reputation, customer base, and competitive position in one nation have

little or no bearing on its ability to successfully compete in another nation.

o Some of the industry examples for multinational competition include beer, life insurance,

and food products.

Global competitive strategy – Companies adopt this strategy when prices and competitive

conditions across the different country markets are strongly linked together and have common

synergies. In a globally competitive industry, a company’s business gets affected by the

changing environments in different countries. The same set of competitors may compete against

each other in several countries. In a global scenario, a company’s overall competitive

advantage is gauged by the cumulative efforts of its domestic operations and the international

operations worldwide.

A good example to illustrate is Sony Ericsson, which has its headquarters in Sweden, Research and

Development setup in USA and India, manufacturing and assembly plants in low wage countries like

China, and sales and marketing worldwide. This is made possible because of the ease in transferring

technology and expertise from country to country.

Industries that have a global competition are automobiles, consumer electronics (like televisions,

mobile phone), watches, and commercial aircraft and so on.

Table 1 portrays the differences in strategies adopted by companies in international and global

operations.

Table 1: Differences between International and Global Strategies

Strategy International Global

Location Selected target countries and

trading areas

Most global businesses operate in North America,

Europe, Asia Pacific, and Latin America

Business Custom strategies to fit the

circumstances of each host

country situation

Same basic strategy worldwide with minor country

customisation where necessary

Product-line Adopted to local culture and

particular needs and expectations

of local buyers

Mostly standardised products sold worldwide,

moderate customisation depending on the

regulatory framework

Production Plants scattered across many host

countries, each producing

versions suitable for the

surrounding environment

Plants located on the basis of maximum competitive

advantage (in low cost countries close to major

markets, geographically scattered to minimise

shipping costs, or use of a few world scale plants to

maximise economies of scale)

Source of supply

of raw materials

Suppliers in host country preferred Attractive suppliers from across the world

Marketing and

distribution

Adapted to practices and culture

of each host country

Much more worldwide coordination; minor

adaptation to host country situations if required

Cross country

connections

Efforts made to transfer ideas,

technologies, competencies and

capabilities that work successfully

in one country to another country

whenever such a transfer appears

advantageous

Efforts made to use almost the same technologies,

competencies, and capabilities in all country

markets (to promote use of a mostly standard

strategy), new successful competitive capabilities

are transferred to different country markets

Company

organisation

Form subsidiary companies to

handle operations in each host

All major strategic decisions closely coordinated at

global headquarters; a global organisational


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country; each subsidiary operates

more or less autonomously to fit

host country conditions

structure is used to unify the operations in each

country

Benefits of globalisation

We have moved from a world where the big eat the small to a world where the fast eat the slow", as

observed by Klaus Schwab of the Davos World Economic Forum. All economic analysts must agree

that the living standards of people have considerably improved through the market growth. With the

development in technology and their introduction in the global markets, there is not only a steady

increase in the demand for commodities but has also led to greater utilization. Investment sector is

witnessing high infusions by more and more people connected to the world's trade happenings with

the help of computers. As per statistics, everyday more than $1.5 trillion is now swapped in the

world's currency markets and around one-fifth of products and services are generated per year are

bought and sold.

Buyers of products and services in all nations comprise one huge group who gain from world trade

for reasons encompassing opportunity charge, comparative benefit, economical to purchase than

to produce, trade's guidelines, stable business and alterations in consumption and production.

Compared to others, consumers are likely to profit less from globalization.

Another factor which is often considered as a positive outcome of globalization is the lower inflation.

This is because the market rivalry stops the businesses from increasing prices unless guaranteed by

steady productivity. Technological advancement and productivity expansion are the other benefits

of globalization because since 1970s growing international rivalry has triggered the industries to

improvise increasingly.

Globalization can be described as a process by which the people of the world are unified into a

single society and functioning together. This process is a combination of economic, technological,

sociocultural and political forces. Globalization, as a term, is very often used to refer to economic

globalization, that is integration of national economies into the international economy through

trade, foreign direct investment, capital flows, migration, and spread of technology. The word

globalization is also used, in a doctrinal sense to describe the neoliberal form of economic

globalization.Globalization is also defined as internationalism, however such usage is typically

incorrect as "global" implies "one world" as a single unit, while "international" (between nations)

recognizes that different peoples, cultures, languages, nations, borders, economies, and ecosystems

exist(http://en.wikipedia.org/).

Globalization has two components: the globalization of market and globalization of production....

Some other benefits of globalization as per statistics

Commerce as a percentage of gross world product has increased in 1986 from 15% to nearly

27% in recent years.

The stock of foreign direct investment resources has increased rapidly as a percentage of gross

world product in the past twenty years.

For the purpose of commerce and pleasure, more and more people are crossing national

borders. Globally, on average nations in 1950 witnessed just one overseas visitor for every 100

citizens. By the mid-1980s it increased to six and ever since the number has doubled to 12.

Worldwide telephone traffic has tripled since 1991. The number of mobile subscribers has

elevated from almost zero to 1.8 billion indicating around 30% of the world population. Internet

users will quickly touch 1 billion.

o Promotes foreign trade and liberalisation of economies.

o Increases the living standards of people in several developing countries through capital

investments in developing countries by developed countries.

o Benefits customers as companies outsource to low wage countries. Outsourcing helps the

companies to be competitive by keeping the cost low, with increased productivity.

o Promotes better education and jobs.

o Leads to free flow of information and wide acceptance of foreign products, ideas,

ethics, best practices, and culture.

o Provides better quality of products, customer services, and standardised delivery models

across countries.

o Gives better access to finance for corporate and sovereign borrowers.

o Increases business travel, which in turn leads to a flourishing travel and hospitality industry

across the world.


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o Increases sales as the availability of cutting edge technologies and production

techniques decrease the cost of production.

o Provides several platforms for international dispute resolutions in business, which facilitates

international trade.

Some of the ill-effects of globalisation are as follows:

Leads to exploitation of labour in several cases.

Causes unemployment in the developed countries due to outsourcing.

Leads to the misuse of IPR, copyrights and so on due to the easy availability of technology,

digital communication, travel and so on.

Influences political decisions in foreign countries. The MNCs increasingly use their economical

powers to influence political decisions.

Causes ecological damage as the companies set up polluting production plants in countries

with limited or no regulations on pollution.

Harms the local businesses of a country due to dumping of cheaper foreign goods.

Leads to adverse health issues due to rapid expansion of fast food chains and increased

consumption of junk food.

Causes destruction of ethnicity and culture of several regions worldwide in favour of more

accepted western culture.

In spite of its disadvantages, globalisation has improved our lives in various fields like communication,

transportation, healthcare, and education.

Q.2 What is culture and in the context of international business environment how does it impact

international business decisions?

Ans: Culture is defined as the art and other signs or demonstrations of human customs, civilisation,

and the way of life of a specific society or group. Culture determines every aspect that is from birth

to death and everything in between it. It is the duty of people to respect other cultures, other than

their culture. Research shows that national ‘‘cultures’’ generally characterise the dominant groups’

values and practices in society, and not of the marginalised groups, even though the marginalised

groups represent a majority or a minority in the society.

Culture is very important to understand international business. Culture is the part of environment,

which human has created, it is the total sum of knowledge, arts, beliefs, laws, morals, customs, and

other abilities and habits gained by people as part of society.

Culture is an important factor for practising international business. Culture affects all the business

functions ranging from accounting to finance and from production to service. This shows a close

relation between culture and international business.

The following are the four factors that question assumptions regarding the impact of global business

in culture:

National cultures are not homogeneous and the impact of globalisation on heterogeneous

cultures is not easily predicted.

Culture is not similar to cultural practice.

Globalisation does not characterise a rupture with the past but is a continuation of prior trends.

Globalisation is only one of many processes involved in cultural change.

Cultural differences affect the success or failure of multinational firms in many ways. The company

must modify the product to meet the demand of the customers in a specific location and use

different marketing strategy to advertise their product to the customers. Adaptations must be made

to the product where there is demand or the message must be advertised by the company. The

following are the factors which a company must consider while dealing with international business:

The consumers across the world do not use same products. This is due to varied preferences and

tastes. Before manufacturing any product, the organisation has to be aware of the customer

choice or preferences.

The organisation must manage and motivate people with broad different cultural values and

attitudes. Hence the management style, practices, and systems must be modified.

The organisation must identify candidates and train them to work in other countries as the

cultural and corporate environment differs. The training may include language training,

corporate training, training them on the technology and so on, which help the candidate to

work in a foreign environment.


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The organisation must consider the concept of international business and construct guidelines

that help them to take business decisions, and perform activities as they are different in different

nations. The following are the two main tasks that a company must perform:

o Product differentiation and marketing – As there are differences in consumer tastes and

preferences across nations; product differentiation has become business strategy all over the

world. The kinds of products and services that consumers can afford are determined by the level

of per capita income. For example, in underdeveloped countries, the demand for luxury

products is limited.

o Manage employees – It is said that employees in Japan were normally not satisfied with their

work as compared with employees of North America and European countries; however the

production levels stayed high. To motivate employees in North America, they have come up

with models. These models show that there is a relation between job satisfaction and production.

This study showed the fact that it is tough for Japanese workers to change jobs. While this trend is

changing, the fact that job turnover among Japanese workers is still lower than the American

workers is true. Also, even if a worker can go to another Japanese entity, they know that the

management style and practices will be quite alike to those found in their present firm. Thus,

even if Japanese workers were not satisfied with the specific aspects of their work, they know

that the conditions may not change considerably at another place. As such, discontent might

not impact their level of production.

The following are the three mega trends in world cultures:

The reverse culture influence on modern Western cultures from growing economies, particularly

those with an ancient cultural heritage.

The trend is Asia centric and not European or American centric, because of the growing

economic and political power of China, India, South Korea, and Japan and also the ASEAN.

The increased diversity within cultures and geographies.

The following are the necessary implications in international business:

Avoid self reference criterion such as, one’s own upbringing, values and viewpoints.

Follow a philosophical viewpoint that considers that many perspectives of a single observation or

phenomenon can be true.

Discover and identify global segments and global niche markets, as national markets are diverse

with growing mobility of products, people, capital, and culture.

Grow the total share market by innovating affordable products and services, and making them

accessible so that, they are affordable for even subsistence level consumers rather than fighting

for market share.

Organise global enterprises around global centres of excellence.

Hofstede’s cultural dimensions

According to Dr. Geert Hofstede, ‘Culture is more often a source of conflict than of synergy. Cultural

differences are a trouble and always a disaster.’

Professor Hofstede carried out a detailed study of how values in the workplace are influenced by

culture. He worked as a psychologist in IBM from 1967 to 1973. At that time he gathered and

analysed data from many people from several countries. Professor Hofstede established a model

using the results of the study which identifies four dimensions to differentiate cultures. Later, a fifth

dimension called ‘long-term outlook’ was added.

The following are the five cultural dimensions:

Power Distance Index (PDI) – This focuses on the level of equality or inequality, between

individuals in the nation’s society. A country with high power distance ranking depicts that

inequality of power and wealth has been allowed to grow within the society. These societies

follow caste system that does not allow large upward mobility of its people. A country with low

power distance ranking depicts the society and de-emphasises the differences between its

people’s power and wealth. In these societies equality and opportunity is stressed for everyone.

Individualism – This dimension focuses on the extent to which the society reinforces individual or

collective achievement and interpersonal relationships. A high individualism ranking depicts that

individuality and individual rights are dominant within the society. Individuals in these societies

form a larger number of looser relationships. A low individualism ranking characterises societies of

a more collective nature with close links between individuals. These cultures support extended

families and collectives where everyone takes responsibility for fellow members of their group.

Masculinity – This focuses on the extent to which the society supports or discourages the

traditional masculine work role model of male achievement, power, and control. A country with

high masculinity ranking shows the country experiences high level of gender differentiation. In


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these cultures, men dominate a major part of the society and power structure, with women

being controlled and dominated by men. A country with low masculinity ranking shows the

country, having a low level of differentiation and discrimination between genders. In low

masculinity cultures, women are treated equal to men in all aspects of the society.

Uncertainty Avoidance Index (UAI) – This focuses on the degree of tolerance for uncertainty and

ambiguity within the society that is unstructured situations. A country with high uncertainty

avoidance ranking shows that the country has low tolerance for uncertainty and ambiguity. A

rule-oriented society that incorporates rules, regulations, laws, and controls is created to minimise

the amount of uncertainty. A country with low uncertainty avoidance ranking shows that the

country has less concern about ambiguity and uncertainty and has high tolerance for a variety

of opinions. A society which is less rule-oriented, readily agrees to changes, and takes greater

risks reflects a low uncertainty avoidance ranking.

Long-Term Orientation (LTO) – Describes the range at which a society illustrates a pragmatic

future oriented perspective instead of a conventional historic or short term point of view. The

Asian countries are scoring high on this dimension. These countries have a long term orientation,

believe in many truths, accept change easily, and have thrift for investment. Cultures recording

little on this dimension, trust in absolute truth is conventional and traditional. They have a small

term orientation and a concern for stability. Many western cultures score considerably low on this

dimension.

In India, PDI is the highest Hofstede dimension for culture with a rank of 77, LTO dimension rank is 61,

and masculinity dimension rank is 62.

Every society has its own unique culture. Culture must not be imposed on individuals of different

culture. For example, the Cadbury Kraft Acquisition, 2009 was a landmark international deal, in

which a U.S. based company Kraft acquired the British chocolate giant, Cadbury which were in

complete extremes in terms of culture. Let us discuss the major cultural elements that are related to

business.

Cultural elements that relate business

The most important cultural components of a country which relate business transactions are:

Language.

Religion.

Conflicting attitudes.

Cross cultural management is defined as the development and application of knowledge about

cultures in the practice of international management, when people involved have diverse cultural

identities.

International managers in senior positions do not have direct interaction that is face-to-face with

other culture workforce, but several home based managers handle immigrant groups adjusted into

a workforce that offers domestic markets.

The factors to be considered in cross cultural management are:

Cross cultural management skills

The ability to demonstrate a series of behaviour is called skill. It is functionally linked to achieving a

performance goal.

The most important aspect to qualify as a manager for positions of international responsibility is

communication skills. The managers must adapt to other culture and have the ability to lead its

members.

The managers cannot expect to force members of other culture to fit into their cultural customs,

which is the main assumption of cross cultural skills learning. Any organisation that tries to enforce its

behavioural customs on unwilling workers from another culture faces conflict. The manager has to

possess the skills linked with the following:

Providing inspiration and appraisal systems.

Establishing and applying formal structures.

Identifying the importance of informal structures.

Formulating and applying plans for modification.

Identifying and solving disagreements.

Handling cultural diversity

Cultural diversity in a work group offers opportunities and difficulties. Economy is benefited when the

work groups are managed successfully. The organisation’s capability to draw, save, and inspire

people from diverse cultures can give the organisation spirited advantages in structures of cost,

creativity, problem solving, and adjusting to change.


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Cultural diversity offers key chances for joint work and co-operative action. Group work is a joint

venture where, the production of two or more individuals or groups working in cooperation is larger

than the combined production of their individual work.

Factors controlling group creativity

On complicated problem solving jobs diverse groups do better than identical groups. Diverse groups

require time to solve issues of working together. In diverse groups, over time, the work experience

helps to overcome gender, racial, and organisational and functional discriminations. But the impact

cannot be evaluated and there is always risk in creating a diverse group. A successful group is

profitable with respect to quick results and the creation of concern for the future. Negative

stereotypes are emphasised if it fails.

Factors related with the industry and company culture are also important. Diverse groups do well

when the members:

o Assist to make group decisions.

o Value the exchange of different points of view.

o Respect each other’s skills and share their own.

o Value the chance for cross-cultural learning.

o Tolerate uncertainty and try to triumph over the inefficiencies that occur when members of

diverse cultures work together.

A diverse group is known to be more creative, where the members are tolerant of differences. The

top management level provides its moral and administrative support, and gives time for the group to

overcome the usual process difficulties. They also provide diversity training, and the group members

are rewarded for their commitment.

Ignore diversity

It may be difficult to manage diversity. It is better to ignore, which is an alternative. The

management must:

o Ignore cultural diversity within the employees.

o Down-play the importance of cultural diversity.

This rejection to identify diversity happens when management:

o Fails to have sufficient awareness and skills to identify diversity.

o Identifies diversity but does not have the skill to manage the diversity.

o Recognises the negative consequences of identifying diversity probably cause greater issues

than ignoring it.

o Thinks the likely benefits of identifying and managing diversity do not validate the expected

expenses.

o Identifies that the job provides no chances for drawing advantages from diversity.

Strategies to ignore diversity may be possible when culture groups are given various jobs, and

sharing required resources are independent in the workplace. Groups and group members are

equally incorporated and work together. In such cases, confusion occurs when the diverse value

systems are not identified that are held by different staff groups.

Q3. Cosmos Limited wants to enter international markets. Will country risk analysis help Cosmos

Limited to take correct decisions? Substantiate your answer

Ans: Country risk analysis is the evaluation of possible risks and rewards from business experiences in a

country. It is used to survey countries where the firm is engaged in international business, and avoids

countries with excessive risk. With globalisation, country risk analysis has become essential for the

international creditors and investors

Overview of Country Risk Analysis

Country Risk Analysis (CRA) identifies imbalances that increase the risks in a cross-border investment.

CRA represents the potentially adverse impact of a country’s environment on the multinational

corporation’s cash flows and is the probability of loss due to exposure to the political, economic,

and social upheavals in a foreign country. All business dealings involve risks. An increasing number of

companies involving in external trade indicate huge business opportunities and promising markets.

Since the 1980s, the financial markets are being refined with the introduction of new products.

When business transactions occur across international borders, they bring additional risks compared

to those in domestic transactions. These additional risks are called country risks which include risks

arising from national differences in socio-political institutions, economic structures, policies,

currencies, and geography. The CRA monitors the potential for these risks to decrease the expected

return of a cross-border investment. For example, a multinational enterprise (MNE) that sets up a


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plant in a foreign country faces different risks compared to bank lending to a foreign government.

The MNE must consider the risks from a broader spectrum of country characteristics. Some

categories relevant to a plant investment contain a much higher degree of risk because the MNE

remains exposed to risk for a longer period of time.

Analysts have categorised country risk into following groups:

Economic risk – This type of risk is the important change in the economic structure that produces

a change in the expected return of an investment. Risk arises from the negative changes in

fundamental economic policy goals (fiscal, monetary, international, or wealth distribution or

creation).

Transfer risk – Transfer risk arises from a decision by a foreign government to restrict capital

movements. It is analysed as a function of a country’s ability to earn foreign currency. Therefore,

it implies that effort in earning foreign currency increases the possibility of capital controls.

Exchange risk – This risk occurs due to an unfavourable movement in the exchange rate.

Exchange risk can be defined as a form of risk that arises from the change in price of one

currency against another. Whenever investors or companies have assets or business operations

across national borders, they face currency risk if their positions are not hedged.

Location risk – This type of risk is also referred to as neighborhood risk. It includes effects caused

by problems in a region or in countries with similar characteristics. Location risk includes effects

caused by troubles in a region, in trading partner of a country, or in countries with similar

perceived characteristics.

Sovereign risk – This risk is based on a government’s inability to meet its loan obligations.

Sovereign risk is closely linked to transfer risk in which a government may run out of foreign

exchange due to adverse developments in its balance of payments. It also relates to political risk

in which a government may decide not to honor its commitments for political reasons.

Political risk – This is the risk of loss that is caused due to change in the political structure or in the

politics of country where the investment is made. For example, tax laws, expropriation of assets,

tariffs, or restriction in repatriation of profits, war, corruption and bureaucracy also contribute to

the element of political risk.

Risk assessment requires analysis of many factors, including the decision-making process in the

government, relationships of various groups in a country and the history of the country. Country risk is

due to unpredicted events in a foreign country affecting the value of international assets,

investment projects and their cash flows. The analysis of country risks distinguishes between the ability

to pay and the willingness to pay. It is essential to analyse the sustainable amount of funds a country

can borrow. Country risk is determined by the costs and benefits of a country’s repayment and

default strategies. The ways of evaluating country risks by different firms and financial institutions

differ from each other. The international trade growth and the financial programs development

demand periodical improvement of risk methodology and analysis of country risks.

Purpose of Country Risk Analysis

Risk arises because of uncertainty and uncertainty occurs due to the lack of reliable information.

Country risk is composed of all the uncertainty that defines the risk of country exposure. The

assessment of country risk is used to incorporate country risk in capital budgeting and modify the

discount rate.

CRA regulates the estimated cash flows and explores the main techniques used to measure a

country’s overall riskiness. It is mainly used by MNCs, in order to avoid countries with excessive risk. It

can be used to monitor countries where the MNC is engaged in international business. Analysing the

country risk helps in evaluating the risk for a planned project considered for a foreign country and

assesses gain and loss possibility outcomes of cross-border investment or export strategy.

Country detailed risk refers to the unpredictability of returns on international business transactions in

view of information associated with a particular country. The techniques used by the banks and

other agencies for country risk analysis can be classified as qualitative or quantitative. Many

agencies merge both qualitative and quantitative information into a single rating. A survey

conducted by the US EXIM bank classified the various methods of country risk assessment used by

the banks into four types. They are:

Fully qualitative method – The fully qualitative method involves a detailed analysis of a country. It

includes general discussion of a country’s economic, political, and social conditions and

prediction. Fully qualitative method can be adapted to the unique strengths and problems of

the country undergoing evaluation.

Structured qualitative method – The structured method uses a uniform format with predetermined

scope. In structured qualitative method, it is easier to make comparisons between countries as it


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follows a specific format across countries. This technique was the most popular among the banks

during the late seventies.

Checklist method – The checklist method involves scoring the country based on specific

variables that can be either quantitative, in which the scoring does not need personal judgment

of the country being scored or qualitative, in which the scoring needs subjective determinations.

All items are scaled from the lowest to the highest score. The sum of scores is then used to

determine the country risk.

Delphi technique – The technique involves a set of independent opinions without group

discussion. As applied to country risk analysis, the MNC can assess definite employees who have

the capability to evaluate the risk characteristics of a particular country. The MNC gets responses

from its evaluation and then may determine some opinions about the risk of the country.

Inspection visits – Involves travelling to a country and conducting meeting with government

officials, business executives, and consumers. These meetings clarify any vague opinions the firm

has about the country.

Other quantitative methods – The quantitative models used in statistical studies of country risk

analysis can be classified as discriminant analysis, principal component analysis, logit analysis

and classification and regression tree method

Data sourcing

The basic data is important to analyse a country. The economic, financial and currency risk

components are based on the variables (quantitative and qualitative variables). The variables must

consider the particularities of each country and the needs of the model used. The standard

variables are used to maintain the regular analysis comparable with similar works of other countries.

Therefore, the first step is to make sure that the historical series of official data are reliable, consistent

and comparable. The standard economic variables that are found mainly in the varied approach

adopted by financial institutions and rating agencies, are associated with the country’s real ability to

repay its commitments. The balance of payments (summary account of economic transactions

among a country and the others nations of the world, during a period) and its evolution through the

years means a strong source of data. The exchange rate (currency risk) is another important variable

considered, as it balances the transactions (balances the prices of goods, services, and capital)

between residents and non-residents. The analysis must consider the historical behavior of the

exchange rate and the policy which made clear whether the country follows a rational economics

approach or it uses the exchange rate as a tool to maintain a forced macroeconomic equilibrium.

Apart from the macroeconomic variables which deal with the external sector of the economy, there

are some other relevant variables such as the interest rate, level of investments, public debt and its

service, internal savings, consumption, GDP or GNP, money supply, inflation rate and so on.

The analysis must be accomplished with qualitative variables, which consider social aspects as

population, life expectancy, rate of birthday, rate of unemployment, level of literacy and so on. The

social-political aspects are necessary for all kind of analysis as they describe the whole setting of the

running economy.

Tools

The risk management demands a regular follow up regarding governmental policies, external and

internal environment, outlook provided by rating agencies, and so on. Following are the tools

recommended:

Chain of value – Includes the main countries that sustain trade relationships with the nation,

broken by sectors and products.

Strength and weakness chart – Focus the key aspects that warn the country.

Table of financial markets performance – Follow up the behavior of bonds and stocks already

issued and to be issued.

Table of macroeconomic variables – Provides alert signals when the behavior of any ratio

presents a relevant change.

The content of country risk analysis mainly involves country history, corporate risk, dependency level,

external environment, domestic financial system, ratios for economic risk evaluation and strength

and weakness chart.

Country history

The historical brief helps to identify aspects that interfere in the future behavior of the country,

reducing the ability to payback any external commitment. The main historical data provides a good

understanding of the key factors which draw the behaviour of the society, the government, the

private sector, the legal environment, the economical, political, and the relationships to neighbour

nations and the world as a whole.


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Corporate risk

Both country risk studies and business risk analysis enhances wealth from the available resources, in

terms of capital, natural resources, technology and labour forces. This clarifies that those kind of

analysis procures extensive knowledge from the business approach for companies, including

financial theory.

Dependency level

The next step after the history in brief, is a clear definition about how the country is positioned in the

world in terms of its wide relationships, economic block in which it belongs to, importance of

international trade and so on. All these aspects are significant to identify the dependency level of

the country. The financial dependency to meet the needs of a country is also a strong concern for

the analyst. In this case, the maturity of debts (internal and external) and the available sources of

financing also help to measure the freedom grades of the country.

External environment

The external trade is an important factor to the development of societies. Globalisation has brought

international business to the center of the discussions and the external environment has become

vital for all countries.

Thus, a complete vision on economic trends, the behavior of financial markets, the forecasts for

conflicts among nations, the improvement of the economic blocks, the level of openness of the

world economy, financial crisis and international liquidity is a framework over which the analysis must

start.

Domestic financial system

The banking sector has implemented many actions to avoid losses, after the international crisis. Basel

Committee has defined some strong measures to be followed by the financial houses and Central

Banks are trying to monitor their jurisdictions. Apart from those procedures, recently Asia and Turkey

crisis have shown that the inspection is not enough to keep the reliability of some domestic system.

The international banks had developed many tools to deal with international crisis. When domestic

banks do not have a consistent risk management policies and adequate provisions to theirs credits,

the country risk happens to be the worst. Therefore, the analysis must consider the health of the

domestic financial system, by evaluating information provided by the Central Banks and, from the

principal banks of the country. Accessing Centrals Bank policies and supervising procedures also

help to evaluate the health of the financial system.

Ratios for economic risk evaluation

Cross-border economic risk analysis evaluates the probable macroeconomic ratios among some

variables. They can be separated into two groups such as domestic and external. The figures must

be presented in historic series (at least five years) to provide information about its progress, which

can be real values, percentages, or relations. The mainly used ratios and variables in case of

domestic economy are the following:

· Gross domestic product (GDP) –· GDP per capita –· GDP growth rate –· Unemployment rate –·

Internal savings or GDP –· Investment or GDP –· Gross domestic fixed investment or variation of GDP –

Gini Index –· Growth domestic fixed investment or gross domestic savings –.· Budget deficit or GDP –·

Internal debt or GDP –

The monetary policy is essential as it deals with the price stability. An economy which presents less

instability in its prices of goods and services, provides huge facilities to decision makers based on

their predictions to expected returns of investments and a firm social, economical and political

environment. All these aspects request a systematic approach over price indicators such as the

following:

· Real interest rate –· Percentage increase in the money supply The mainly used ratios and variables

in case of external economy are the following:

· External debt or GDP –· Short term debts and reserves –· Exchange currency rate –· External debt

services and exports –.

Strength and weakness chart

In order to explain the significant aspects provided by the analysis, the strength and weakness chart

can be used to merge each strength and weakness with the related scenario. is a model of

relationships among several variables (quantitative and qualitative) to show their interdependency

and the complexity of analysis.

Q4. How can managers in international companies adjust to the ethical factors influencing

countries? Is it possible to establish international ethical codes? Briefly explain?


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Ans: Ethics can be defined as the evaluation of moral values, principles, and standards of human

conduct and its application in daily life to determine acceptable human behaviour.

Business ethics pertains to the application of ethics to business, and is a matter of concern in the

corporate world. Business ethics is almost similar to the generally accepted norms and principles.

Behaviour that is considered unethical and immoral in society, for example dishonesty, applies to

business as well.

Managers are influenced by three factors affecting ethical values. These factors have unique value

systems that have varying degrees of control over managers.

Religion – Religion is one of the oldest factors affecting ethics. Despite the differences in religious

teachings, religions agree on the fundamental principles and ethics. All major religions preach the

need for high ethical standards, an orderly social system, and stress on social responsibility as

contributing factors to general well-being.

Culture – Culture refers to a set of values and standards that defines acceptable behaviour passed

on to generations. These values and standards are important because the code of conduct of

people reflects on the culture they belong to. Civilisation is the collective experience that people

have passed on through three distinct phases: the hunting and gathering phase, agriculture phase,

and the industrial phase. These phases reflect the changing economic and social arrangements in

human history.

Law – Law refers to the rules of conduct, approved by the legal system of a country or state that

guides human behaviour. Laws change and evolve with emerging and changing issues. Every

organisation is expected to abide the law, but in the pursuit of profit, laws are frequently violated.

The most common breach of law in business is tax evasion, producing inferior quality goods, and

disregard for environmental protection laws.

Ethics is significant in all areas of business and plays an important role in ensuring a successful

business. The role of business ethics is evident from the conception of an idea to the sale of a

product. In an organisation, every division such as sales and marketing, customer service, finance,

and accounting and taxation has to follow certain ethics.

Public image – In order to gain public confidence and respect, organisations must ascertain that

they are honest in their transactions. The services or products of a business affect the lives of

thousands of people. It is important for the top management to impart high ethical standards to

their employees, who develop these services or products.

A company that is ethically and socially responsible has a better public image. People tend to

favour the products and services of such organisations. Investors’ trust is just as important as public

image for any business. A company that practices good ethical creates a positive impression

among its stakeholders.

Management’s credibility with employees – Common goals and values are developed when

employees feel that the management is ethical and genuine. Management’s credibility with

employees and the public are intertwined. Employees feel proud to be a part of an organisation

that is respected by the public. Generous compensations and effective business strategies do not

always guarantee employee loyalty; organisation ethics is equally significant. Thus, companies

benefit from being ethical because they attract and retain good and loyal employees.

Better decision-making – Decisions made by an ethical management are in the best interests of the

organisation, its employees, and the public. Ethical decisions take into account various social,

economic and ethical factors.

Profit maximisation – Companies that emphasise on ethical conduct are successful in the long run,

even though they lose money in the short run. Hence, a business that is inspired by ethics is a

profitable business. Costs of audit and investigation are lower in an ethical company.

Protection of society – In the absence of proper enforcement, organisations are responsible to

practice ethics and ensure mechanisms to prevent unlawful events. Thus, by propagating ethical

values, a business organisation can save government resources and protect the society from

exploitation.

Most countries have similar ethical values, but are practiced differently. This section deals with the

way individuals in different countries approach ethical issues, and their ethically acceptable

behaviour. With the rise in global firms, issues related to ethical values and traditions become more

common. These ethical issues create complications to Multi-National Companies (MNCs) while

dealing with other countries for business. Hence, many companies have formulated well-designed

codes of conduct to help their employees.

Two of the most prominent issues that managers in MNCs operating in foreign countries face are

bribery and corruption and worker compensation.


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Bribery and corruption – Bribery can be defined as the act of offering, accepting, or soliciting

something of value for the purpose of influencing the action of officials in the discharge of their

duties. Corruption is the abuse of public office for personal gain. The issue arises when there are

differences in perception in different countries. For example, in the Middle East, it is perfectly

acceptable to offer an official a gift. In Britain it is considered as an attempt to bribe the official, and

hence, considered unlawful.

Worker compensation – Businesses invest in production facilities abroad because of the availability

of low-cost labour, which enables them to offer goods and services at a lower price than their

competitors. The issue arises when workers are exploited and are underpaid compared to the

workers in the parent country who are paid more for the same job. The disparity arises due to the

differences in the regulatory standards in the two countries.

Earlier, we believed that ethics is a prerogative of individuals, but now this perception has immensely

changed. Many companies use management techniques to encourage ethical behaviour at an

organisational level.

Code of conduct for MNCs

The code of conduct for MNCs refers to a set of rules that guides corporate behaviour. These rules

prescribe the duties and limitations of a manager. The top management must communicate the

code of conduct to all members of the organisation along with their commitment in enforcing the

code.

Some of the ethical requirements for international companies are as follows:

o Respect basic human rights.

o Minimise any negative impact on local economic policies.

o Maintain high standards of local political involvement.

o Transfer technology.

o Protect the environment.

o Protect the consumer.

o Employ labour practices that are not exploitative.

When a manager of an international firm faces an ethical problem, certain models help in solving

these ethical issues

Culture is a major factor which influences marketing decisions and practices in a foreign country. For

example, in the middle-eastern countries the prior approval of the governing authorities should be

taken if a firm plans to advertise a product related to women’s apparel, as showcasing some

aspects of women clothing is considered immodest and immoral.

Q.5 Discuss the international marketing strategies. How is it different from domestic marketing

strategies?

Ans: International marketing refers to marketing of goods and products by companies overseas or

across national borderlines. The techniques used while dealing overseas is an extension of the

techniques used in the home country by the company.

Taking into account the various conditions on which markets vary and depend, appropriate

marketing strategies should be devised and adopted. Like, some countries prevent foreign firms from

entering into its market space through protective legislation. Protectionism on the long run results in

inefficiency of local firms as it is inept towards competition from foreign firms and other

technological advancements. It also increases the living costs and protects inefficient domestic

firms.

To counter this scenario firms must learn how to enter foreign markets and increase their global

competitiveness. Firms that plan to do business in foreign land find the marketplace different from

the domestic one. Market sizes, customer preferences, and marketing practices all vary; therefore

the firms planning to venture abroad must analyse all segments of the market in which they expect

to compete.

The decision of a firm to compete internationally is strategic; it will have an effect on the firm,

including its management and operations locally. The decision of a firm to compete in foreign

markets has many reasons. Some firms go abroad as the result of potential opportunities to exploit

the market and to grow globally. And for some it is a policy driven decision to globalise and to take

advantage by pressurising competitors.

But, the decision to compete abroad is always a strategic down to business decision rather than

simply a reaction. Strategic reasons for global expansion are:

o Diversifying markets that provide opportunistic global market development.


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o Following customers abroad (customer satisfaction).

o Exploiting different economic growth rates.

o Pursuing a global logic or imperative to harvest new markets and profits.

o Pursuing geographic diversification.

o Globalising for defensive reasons.

o Exploiting product life cycle differences (technology).

o Pursuing potential abroad.

Likewise, there can be other reasons like competition at home, tax structures, comparative

advantage, economic trends, demographic conditions, and the stage in the product life cycle. In

order to succeed, a firm should carefully look at their geographic expansion and global marketing

strategy. To a certain extent, a firm makes a decision about its extent of globalisation by taking a

stance that may span from entirely domestic to a global reach where the company devotes its

entire marketing strategy to global competition. In the process of developing an international

marketing strategy, the firm may decide to do business in its home-country (domestic operations)

only or host-country (foreign country) only.

Segmentation

Firms that serve global markets can be segregated into several clusters based on their similarities.

Each such cluster is termed as a segment. Segmentation helps the firms to serve the markets in an

improved way. Markets can be segmented into nine categories, but the most common method of

segmentation is on the basis of individual characteristics, which include the behavioural,

psychographic, and demographic segmentations. The basis of behavioural segmentation is the

general behavioural aspects of the customers. Demographic segmentation considers the factors like

age, culture, income, education and gender. Psychographic segmentation takes into account:

beliefs, values, attitudes, personalities, opinions, lifestyles and so on.

Market positioning

The next step in the marketing process is, the firms should position their product in the global market.

Product positioning is the process of creating a favourable image of the product against the

competitor’s products. In global markets product positioning is categorised as high-tech or high–

touch positioning.

One challenge that firms face is to make a trade-off between adjusting their products to the specific

demands of a country and gaining advantage of standardisation such as the maintenance of a

consistent global brand image and cost savings. This is task is not easy.

International product policy

Some thinkers of the industry tend to draw a distinction between conventional products and

services, stressing on service characteristics such as heterogeneity (variation in standards among

providers, frequently even among different locations of the same firm), inseparability from

consumption, intangibility, and perishability. Typically, products are composed of some service

component like, documentation, a warranty, and distribution. These service components are an

integral part of the product and its positioning.

Firms have a choice in marketing their products across markets. Many a times, firms opt for a

strategy which involves customisation, through which the firm introduces a unique product in each

country, believing that tastes differ so much between countries that it is necessary to create a new

product for each market. On the other hand, standardisation proposes the marketing of one global

product, with the belief that the same product can be sold in different countries without significant

changes. For example, Intel microprocessors are the same irrespective of the country in which they

are sold.

Finally, in most cases firms will go for some kind of adaptation. Here, when moving a product

between markets minor modifications are made to the product. For example, in U.S. fuel is relatively

cheap, therefore cars have larger engines than the cars in Asia and Europe; and then again, much

of the design is identical or similar.

International pricing decisions

Pricing is the process of ascertaining the value for the product or service that will be offered for sale.

In international markets, making pricing decisions is entangled in difficulties as it involves trade

barriers, multiple currencies, additional cost considerations, and longer distribution channels. Before

establishing the prices, the firm must know its target market well because when the firm is clear

about the market it is serving, then it can determine the price appropriately. The pricing policy must

be consistent with the firms overall objectives. Some common pricing objectives are: profit, return on

investment, survival, market share, status quo, and product quality.

The strategies for international pricing can be classified into the following three types:


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· Market penetration· Market holding: · Market skimming:

The factors that influence pricing decisions are inflation, devaluation and revaluation, nature of

product or industry and competitive behaviour, market demand, and transfer pricing.

The approach taken by company towards pricing when operating in international markets are

ethnocentric, polycentric, and geocentric.

Price can be defined by the following equation:

The pricing decision enables us to change the price in many ways, some of them are:

· “Sticker” price changes –. · Change quantity –· Change quality –· Change terms –

Transfer pricing

Transfer pricing is the process of setting a price that will be charged by a subsidiary (unit) of a multi-

unit firm to another unit for goods and services, which are sold between such related units.

Transfer pricing is determined in three ways: market based pricing, transfer at cost and cost-plus

pricing. The Arm’s Length pricing rule is used to establish the price to be charged to the subsidiary.

Many managers consider transfer pricing as non-market based. The reason for transfer pricing may

be internal or external. Internal transfer pricing include motivating managers and monitoring

performance. External factors include taxes, tariffs, and other charges.

Transfer Pricing Manipulation (TPM) is used to overcome these reasons. Governments usually

discourage TPM since it is against transfer pricing, where transfer pricing is the act of pricing

commodities or services. However, in common terminology, transfer pricing generally refers TPM.

International advertising

International advertising is usually associated with using the same brand name all over the world.

However, a firm can use different brand names for historic reasons. The acquisition of local firms by

global players has resulted in a number of local brands. A firm may find it unfavourable to change

those names as these local brands have their own distinctive market.

The purpose of international advertising is to reach and communicate to target audiences in more

than one country. The target audience differ from country to country in terms of the response

towards humour or emotional appeals, perception or interpretation of symbols and stimuli and level

of literacy. Sometimes, globalised firms use the same advertising agencies and centralise the

advertising decisions and budgets. In other cases, local subsidiaries handle their budget, resulting in

greater use of local advertising agencies.

International advertising can be thought of as a communication process that transpires in multiple

cultures that vary in terms of communication styles, values, and consumption patterns. International

advertising is a business activity and not just a communication process. It involves advertisers and

advertising agencies that create ads and buy media in different countries. This industry is growing

worldwide. International advertising is also reckoned as a major force that mirrors both social values,

and propagates certain values worldwide.

International promotion and distribution

Distribution of goods from manufacturer to the end user is an important aspect of business.

Companies have their own ways of distribution. Some companies directly perform the distribution

service by contacting others whereas a few companies take help from other companies who

perform the distribution services. The distribution services include:

The purchase of goods.

The assembly of an attractive assortment of goods.

Holding stocks.

Promoting sale of goods to the customer.

The physical movement of goods.

In international marketing, companies usually take the advantage of other countries for the

distribution of their products. The selection of distribution channel is helpful to gain the competitive

advantage. The distribution channel is also dependent on the way to manage and control the

channel. Selecting the distribution channel is very important for agents and distributors.

Domestic vs. International marketing

Domestic marketing refers to the practice of marketing within a firm’s home country. Whereas

International or foreign marketing is the practice of marketing in a foreign country; the marketing is

for the domestic operations of the firm in that country.

Domestic marketing finds the "how" and "why" a product succeeds or fails within the firm’s home

country and how the marketing activity affects the outcome. Whereas, foreign marketing deals with


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these questions and tries to find answers according to the foreign market conditions and it provides

a micro view of the market at the firm’s level.

In domestic marketing a firm has insight of the marketing practices, culture, customer preferences,

climate and so on of its home country, while it is not totally aware of the policies and the market

conditions of the foreign country.

The stages that have led to achieve global marketing are:

Domestic marketing – Firms manufacture and sell products within the country. Hence, there is no

international phenomenon.

Export marketing – Firms start exporting products to other countries. This is a very basic stage of

global marketing. Here, the products are developed based on the company’s domestic market

although the goods are exported to foreign countries.

International marketing – Now, Firms start to sell products to various countries and the approach

is ‘polycentric’, that is, making different products for different countries.

Multinational marketing – In this stage, the number of countries in which the firm is doing business

gets bigger than that in the earlier stage. And hence, the company identifies the regions to

which the company can deliver same product instead of producing different goods for different

countries. For example, a firm may decide to sell same products in India, Sri lanka and Pakistan,

assuming that the people living in this region have similar choice and at the same time offering

different product for American countries. This approach is termed ‘regiocentric approach’.

Global marketing – Company operating in various countries opts for a common single product in

order to achieve cost efficiencies. This is achieved by analysing the requirements and the choice

of the customers in those countries. This approach is called ‘Geocentric approach’.

The practice of marketing at the international stage does not designate any country as domestic or

foreign. The firm is not considered as the corporate citizen of the world as it has a home base.

The firm must not have a ’single marketing plan’, because there are differences between the target

markets (that is domestic or international markets). There should never be a rigid marketing

campaign. A firm that is successful internationally first obtains success locally.

Few approaches that you can consider for an international marketing are:

Advertise as a foreign product – By doing so, the product will be considered as genuine and

original in some countries.

Joint partnership with a local firm – finding a firm that has already established credibility will

benefit a lot. The product will be considered as a local product by following this marketing

approach.

Licensing – You can sell the rights of your product to a foreign firm. Here the problem is that the

firm may not maintain the quality standard and therefore may hurt the image of the brand.

Culture is a major factor which influences marketing decisions and practices in a foreign country. For

example, in the middle-eastern countries the prior approval of the governing authorities should be

taken if a firm plans to advertise a product related to women’s apparel, as showcasing some

aspects of women clothing is considered immodest and immoral.

Q.6 Explain briefly the international financial management components with examples and

applicability

Ans: The term ‘Financial Management’ refers to the proper maintenance of all the monetary

transactions of the organisation. It also means recording of transactions in a standard manner that

will show the financial position and performance of the organisation. The Financial Management

can be categorised into domestic and international financial management.

The domestic financial management refers to managing financial services within the country.

International financial management refers to managing finance and share between the countries.

The main aim of international finance management is to maximise the organisation’s value that in

turn will increase the impact on the wealth of the stockholders. When the doors of liberalisation

opened, entrepreneurs capitalised the opportunity to step their foot to conduct business in different

parts of the world.

International trade gave way for the growth of international business. For a corporation to be

successful, it is vital to manage the finance and business accounts appropriately. The rise in

significance and complexity of financial administration in a global environment creates a great

challenge for financial managers. The contributions of different financial innovations like currency

derivative, international stock listing, and multicurrency bonds have necessitated the accurate


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management of the flow of international funds through the study of international financial

management.

The International Financial Management (IFM) came to its existence when the countries all over the

world started opening their doors for each other. This phenomenon is also called as liberalisation. But

after the end of the Second World War, the integration in terms of foreign activities has grown

substantially. The firms of all types are now opting to operate their business and deploy their

resources abroad. Furthermore, the differences between the countries have persisted that has given

rise to the prevalence of market imperfections

Components of International Financial Management

Foreign exchange market

The Foreign exchange or the forex markets facilitates the participants to obtain, trade, exchange

and speculate foreign currency. The foreign exchange market consists of banks, central banks,

commercial companies, hedge funds, investment management firms and retail foreign exchange

brokers and investors. It is considered to be the leading financial market in the world. It is vital to

realise that the foreign exchange is not a single exchange, but is created from a global network of

computers that connects the participants from all over the world.

The foreign exchange market is immense in size and survives to serve a number of functions ranging

from the funding of cross-border investment, loans, trade in goods, trade in services and currency

speculation. The participant in a foreign exchange market will normally ask for a price.

The trading in the foreign exchange market may take place in the following forms:

Outright cash or ready – foreign exchange currency deals that take place on the date of the

deal.

Next day – foreign exchange currency deals that take place on the next working day.

Swap – Simultaneous sale and purchase of identical amounts of currency for different maturities.

“Spot” and “Forward” contracts – A Spot contract is a binding obligation to buy or sell a definite

amount of foreign currency at the existing or spot market rate. A forward contract is a binding

obligation to buy or sell a definite amount of foreign currency at the pre-agreed rate of

exchange, on or before a certain date.

The advantage of spot dealing has resulted in a simplest way to deal with all foreign currency

requirements. It carries the greatest risk of exchange rate fluctuations due to lack of certainty of the

rate until the deal is carried out. The spot rate that is intended to receive will be set by current

market conditions, the demand and supply of currency being traded and the amount to be dealt.

In general, a better spot rate can be received if the amount of dealing is high. The spot deal will

come to an end in two working days after the deal is struck.

A forward market needs a more complex calculation. A forward rate is based on the existing spot

rate plus a premium or discounts which are determined by the interest rate connecting the two

currencies that are involved. For example, the interest rates of UK are higher than that of US and

therefore a modification is made to the spot rate to reflect the financial effect of this differential over

the period of the forward contract. The duration will be up to two years for a forward contract. A

variation in foreign exchange markets can be affected to any company whether or not they are

directly involved in the international trade or not. This is often referred to as ‘Economic’ foreign

exchange and most difficult to protect a business.

The three ways of managing risks are as follows:

Choosing to manage risk by dealing with the spot market whenever the need of cash flow rises.

This will result in a high risk and speculative strategy since one will not know the rate at which a

transaction is dealt until the day and time it occurs. Managing the business becomes difficult if it

depends on the selling or buying the currency in the spot market.

The decision must be made to book a foreign exchange contract with the bank whenever the

foreign exchange risk is likely to occur. This will help to fix the exchange rate immediately and will

give a clear idea of knowing the exact cost of foreign currency and the amount to be received

at the time of settlement whenever this due occurs.

A currency option will prevent unfavourable exchange rate movements in the similar way as a

forward contract does. It will permit gains if the markets move as per the expectations. For this

base, a currency option is often demonstrated as a forward contract that can be left if it is not

followed. Often banks provide currency options which will ensure protection and flexibility, but

the likely problem to arise is the involvement of premium of particular kind. The premium involved

might be a cash amount or it could also influence into the charge of the transaction.

Foreign currency derivatives


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Currency derivative is defined as a financial contract in order to swap two currencies at a

predestined rate. It can also be termed as the agreement where the value can be determined from

the rate of exchange of two currencies at the spot. Hence, the spot market exposures can be

enclosed with the currency derivatives. The main advantage from derivative hedging is the basket

of currency available.

Figure 1 describes the examples of currency derivatives. The derivatives can be hedged with other

derivatives. In the foreign exchange market, currency derivatives like the currency features,

currency options and currency swaps are usually traded. The agreement undertaken to exchange

cash flow streams in one currency for cash flow streams in another currency in future is provided by

currency swaps. These will help to increase the funds of foreign currency from the cheapest sources.

Figure 1: Example for Foreign Currency Derivatives

Some of the risks associated with currency derivatives are:

Credit risk takes place, arising from the parties involved in a contract.

Market risk occurs due to adverse moves in the overall market.

Liquidity risks occur due to the requirement of available counterparties to take the other side of

the trade.

Settlement risks similar to the credit risks occur when the parties involved in the contract fail to

provide the currency at the agreed time.

Operational risks are one of the biggest risks that occur in trading derivatives due to human error.

Legal risks pertain to the counterparties of currency swaps that go into receivership while the

swap is taking place.

International monetary systems

The international monetary systems represent the set of rules that are agreed internationally along

with its conventions. It also consists of set of rules that govern international scenario, supporting

institutions which will facilitate the worldwide trade, the investment across cross-borders and the

reallocation of capital between the states.

International monetary systems provide the mode of payment acceptable between buyers and

sellers of different nationality, with addition to deferred payment. The global balance can be

corrected by providing sufficient liquidity for the variations occurring in trade. Thereby it can be

operated successfully.

The gold and gold bullion standards

The gold standard was the first modern international system. It was operating during the late 19th

and early 20th centuries, the standard provided for the free circulation between nations of gold

coins of standard specification. The gold happened to be the only standard of value under the

system. The advantages of this system depend in its stabilising influence. Any nation which exports

more than its import would receive gold in payment of the balance. This in turn has resulted in the

lowered value of domestic currency. The higher prices lead to the decreased demands for exports.

The sudden increase in the supply of gold may be due to the discovery of rich deposit, which in turn

will result in the increase of price abruptly.

This standard was substituted by the gold bullion standard during the 1920s; thereby the nations no

longer minted gold coins. Instead, reversed their currencies with gold bullion and determined to buy

and sell the bullion at a fixed cost. This system was also discarded in the 1930s.

The gold-exchange system

Trading was conducted internationally with respect to the gold-exchange standard following World

War II. In this system, the value of the currency is fixed by the nations with respect to some foreign

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currency but not with respect to gold. Most of the nations fixed their currency to the US dollar funds

in the United States. With a view to maintain a stable exchange rate at the global level, the

International Monetary Fund (IMF) was created at the ‘Bretton Woods international Conference’

held in 1944. The drain on the US gold reserves continued up to the 1970s. Later in 1971, the gold

convertibility was abandoned by the United States leaving the world without a single international

monetary system.

Floating exchange rates and recent development

After the abundance of the gold convertibility by the US, the IMF in 1976 decided to be in

agreement on the float exchange rates. The gold standard was suspended and the values of

different currencies were determined in the market. The ‘Japanese yen’ and the ‘German

Deutschmark’ strengthened and turned out to be increasingly important in international financial

market, at the same time the US dollar diminished its significance. The Euro was set up in financial

market in 1999 as a replacement for the currencies. Hence, it became the second most commonly

used currency after the dollar in the international market. Many large companies opt to use euro

rather than the dollar in bond trading with a goal to receive better exchange rates. Very recently

the some of the members of Organisation of Petroleum Exporting Countries (OPEC) such as Saudi

Arabia, Iraq have opted to trade petroleum in Euro than in Dollar.

International financial markets

International foreign markets provide links connecting the financial markets of each country and

independent markets external to the authority of any one country. The heart of the international

financial market is being governed by the market of currency where the foreign currency is

denominated by the international trade and investment. Hence the purchase of goods and services

is preceded by the purchase of currency.

The purpose of the foreign currency markets, international money markets, international capital

markets and international securities markets are as follows:

The foreign currency markets – The foreign currency market is an international market that is

familiar in structure. This means that there exists no central place where the trading can take

place. The ’market’ is actually the telecommunications like among financial institutions around

the globe and opens for business at any time. The greater part of the worlds that deal in foreign

currencies is still taking position in the cities where international financial activity is centred.

International money markets – A money market can be conventionally defined as a market for

accounts, deposits or deposits that include maturities of one year or less. This is also termed as

the Euro currency markets which constitute an enormous financial market that is beyond the

influence and supervision of world financial and government authorities. The Euro currency

market is a money market for depositing and borrowing money located outside the country

where that money is officially permitted tender. Also, Euro currencies are bank deposits and

loans existing outside any particular country.

International capital markets – The international capital provides links among the capital markets

of individual countries. It also comprises a separate market of their own, the capital market that

flows in to the Euro markets. The firms enjoy the freedom to raise capital, debit, fixed or floating

interest rates and maturities varying from one month to thirty years in an international capital

markets.

International security markets – The banks have experienced the greatest growth in the past

decade because of the continuity in providing large portion of the international financial needs

of the government and business. The private placements, bonds and equities are included in the

international security market.

The following are the reasons given for the enormous growth in the trading of foreign currency:

Deregulation of international capital flows – Without the major government restrictions, it is

extremely simple to move the currencies and capital around the globe. The majority of the

deregulation that has differentiated government policy over the past 10 to 15 years.

Gain in technology and transaction cost efficiency – The advancements in technology is not only

taking place in the distribution of information, in addition to the performance of exchange or

trading. This has resulted greatly to the capacity of individuals on these markets to accomplish

instantaneous arbitrage.

Market upwings – The financial markets have become increasingly unstable over recent years.

There are faster swings in the stock values and interest rates, adding to the enthusiasm for

moving further capital at faster rates.

MB0053 - International Business Management - Set 1

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Transcript of MB0053 - International Business Management - Set 1