Sixth Edition
INTERNATIONAL FINANCIAL MANAGEMENT LM
BP
B
E A
IS
Vyup Vy upttak akes esh h Sh Shaaran
International Financial Management
International Financial Management SIXTH EDITION
Vyuptakesh V yuptakesh Sharan Emeritus Professor Chandragupt Institute of Management Patna and Former Emeritus Fellow South Asian Studies Division School of International Studies Jawaharlal Nehru University New Delhi
New Delhi-110001 2012
` 395.00
INTERNATIONAL FINANCIAL MANAGEMENT, Sixth Edition Vyuptakesh Sharan
© 2012 by PHI Learning Private Limited, New Delhi. All rights reserved. reserved. No part of this book may be reproduced in any form, by mimeograph or any other means, without permission in writing from the publisher. ISBN-978-81-203-4586-7
The export rights of this book are vested solely with the publisher. Fourteenth Printing (Sixth Edition)
º
º º
May, 2012
Published by Asoke K. Ghosh, PHI Learning Private Limited, M-97, Connaught Circus, New Delhi-110001 and Printed by Mudrak, 30-A, Patparganj, Delhi-110091.
Dedicated to My Parents Smt. Kalyani Devi and Shri Hrishikesh Sharan
Contents
Preface
xv
Preface to the First Edition
Part 1
xvii
Internatio Inter national nal Financ Financial ial and Monet Monetary ary Envir Environmen onmentt
1. International Financial Management—An Overview Learning Objectiv Objectives es 3 International Business and Its Modes 3 Multinational Corporations: The Key Participant in International Financial Functions 5 Nature of International Financial Functions and the Scope of IFM Factors Leading to Fast Strides in International Financial Functions IFM and Domestic Financial Management 11 Structure of the Book 11 Review Questions 12 References Referenc es 13 Suggested Further Reading 13 2. International Flow of Funds: Balance of Payments Learning Objective Objectivess 14 Structure of Balance of Payments 14 Equilibrium, Disequilibrium and Adjustment 20 Different Approaches to Adjustment 21 Capital Account Convertibility 28 Summary 31 C ASE STUDY 1 INDIA ’S B ALANCE OF P AYMENTS DURING LIBERAL ECONOMIC REGIME 32 vii
3 – 13
6 9
14 – 41
viii
Contents
C ASE STUDY 2 C APITAL A CCOUNT CCOUNT C ONVERTIBILITY IN INDIA Review Questions 39 References Referenc es 40 Suggested Further Reading 41
33
3. Developments in International Monetary System Learning Objective Objectivess 42 Specie Commodity Standard 43 Gold Standard 43 Bretton Woods System of Exchange Rates 47 Exchange Rate Regime Since 1973 49 International Liquidity 57 IMF Solution for Financial Crisis 63 Summary 66 STUDY TOPIC CHANGING F ACE OF EUROPEAN ECONOMIC AND MONETARY UNION (EMU) 67 Review Questions 71 References Referenc es 72 Suggested Further Reading 74 4. E Ex xchange Rate Mechanism Learning Objective Objectivess 75 Exchange Rate Quotations 76 Nominal, Real and Effective Exchange Rates 80 Determination of Exchange Rate in the Spot Market 83 Factors Influencing Exchange Rate 84 Exchange Rate Determination in Forward Market 91 Theories of Exchange Rate Behaviour 96 Summary 99 C ASE STUDY INTRODUCTION OF M ANAGE D FLOATING E XCHANGE R ATE REGIME IN INDIA 100 Review Questions 102 References Referenc es 104 Suggested Further Reading 107
Part 2
42–74
75 – 10 7
Markets Mark ets for Fore Foreign ign Exch Exchange ange and Deri Derivativ vatives es
5. F Fo oreign Exchange Market Learning Objective Objectivess 111 Distinctive Features 112 Major Participants 112 Spot Market 114 Forward Market 116 Summary 121 STUDY TOPIC INDIAN FOREIGN E XCHANG E M ARKET
111 –128
122
Contents
ix
C ASE STUDY FOREIGN E XCHANGE TRANSACTIONS TURNOVER IN INDIAN M ARKET 125 Review Questions 126 Suggested Further Reading 128 6. Market for Currency Futures Learning Objective Objectivess 129 Recent Upsurge in Currency Futures Contracts 129 Features of Currency Futures Contracts 130 Hedging in Currency Futures Market 135 Speculation with Currency Futures 136 Futures Prices, Forward Prices and Expected Spot Prices on Delivery 139 Summary 140 STUDY TOPIC CURRENCY FUTURES M ARKET IN INDIA 141 Review Questions 142 References Referenc es 144 Suggested Further Reading 145
12 9 – 1 45
7. Market for Currency Options Learning Objective Objectivess 146 Broad Features 147 Options Terminology 150 Gains or Losses of the Option Traders 151 Options Pricing 153 Hedging with Currency Options 156 Speculating with Options 158 Summary 163 STUDY TOPIC CURRENCY OPTIONS TRADING AT PHILADELPHIA STOCK E XCHANGE (PHLX) 164 C ASE STUDY CURRENCY OPTIONS TRADING IN INDIA 165 Review Questions 166 References Referenc es 168 Suggested Further Reading 168
146 –1 68
Partt 3 Par
Foreig For eign n Exchan Exchange ge Expos Exposur ure e Manage Managemen mentt
8. Forecasting Exchange Rates Learning Objective Objectivess 171 Need for Exchange Rate Forecasts 172 Techniques of Forecasting 174 Forecast in a Controlled Exchange Rate Regime Summary 179 Review Questions 179 References Referenc es 180 Suggested Further Reading 181
1 71 –1 81
178
x
Contents
9. Nature and Measurement of Foreign Exchange Exposure Learning Objective Objectivess 182 The Concept 182 Transaction Exposure 184 Real Operating Exposure 187 Translation Exposure 190 Summary 195 CCOUNTING STANDARD 11 OF INDIA STUDY TOPIC A NOTE ON A CCOUNTING Review Questions 197 References Referenc es 199 Suggested Further Reading 199 10. Management of Foreign Exchange Exposure Learning Objective Objectivess 200 Need for Hedging 200 Hedging of Transaction Exposure 201 Hedging of Real Operating Exposure 209 Managing Translation Exposure 212 Summary 213 C ASE STUDY M ANAGIN G E XCHANGE R ATE R ISK Review Questions 214 References Referenc es 216 Suggested Further Reading 216 Part Par t 4
18 2 –1 99
196
20 0 – 2 16
214
Intern Int ernati ationa onall Inve Investm stment ent Dec Decisi ision on
11. Foreign Direct Investment Learning Objective Objectivess 219 Theories of FDI 220 Costs and Benefits of FDI 225 Strategy for FDI 229 Control of MNCs 234 Summary 236 C ASE STUDY FDI AND DEVELOPMENT IN LEAST DEVELOPED COUNTRIES (LDCS) 238 Review Questions 239 References Referenc es 240 Suggested Further Reading 242
219 –2 42
12. International Capital Budgeting Learning Objectiv Objectives es 243 Evaluation Criteria 244 Computation of the Cash Flow 247 Cost of Capital 256 Adjusted Present Value Approach 261 Sensitivity Analysis 263 Real Options and Project Appraisal 264
2 43 – 2 75
Contents
xi
Evaluating M&As 266 Non-financial Factors in Capital Budgeting 269 Summary 270 C ASE STUDY D AIICHI S ANKYO OF J APAN BUYS OUT 34.8 PER CENT STAKE IN R ANBAXY OF INDIA 271 Review Questions 272 References Referenc es 274 Suggested Further Reading 275 13. Evaluation and Management of Political Risk Learning Objective Objectivess 276 Meaning and Forms of Political Risk 276 Evaluation of Political Risk 279 Management of Political Risk 281 Summary 285 C ASE STUDY 1 POLITICAL TURMOIL AND FDI IN P AKISTAN L ATE 2000S C ASE STUDY 2 SOME CASES OF POLITICAL RISKS IN MINERALS-RICH HOST COUNTRIES 286 Review Questions 287 References Referenc es 288 Suggested Further Reading 289 14. International Portfolio Investment Learning Objective Objectivess 290 Concept of Optimal Portfolio 291 Benefits of International Portfolio Investment 298 Problems of International Investment 299 Modes of International Portfolio Investment 301 Identification of Optimal International Investment Portfolio Summary 303 STUDY TOPIC TRENDS IN FIIS’ INVESTMENT IN INDIA 303 Review Questions 306 References Referenc es 307 Suggested Further Reading 308
Part Pa rt 5
27 6 –2 89
285
2 90 –3 08
301
Inter Int ernat nation ional al Finan Financin cing g Decisi Decisions ons
15. Overview of the International Financial Market Learning Objective Objectivess 311 Channels for International Flow of Funds 312 Changing Structure of the International Financial Market Selection of Sources and Forms of Funds 319 Summary 322 Review Questions 323 References Referenc es 324 Suggested Further Reading 324
311– 324
313
xii
Contents
16. Multilateral Development Banks Learning Objective Objectivess 325 The World Bank 325 International Finance Corporation (IFC) 333 Asian Developme Development nt Bank 336 Summary 340 C ASE STUDY A N E VALUATI ON OF IFC’ S FRONTIER COUNTRY S TRATEGY Review Questions 345 References Referenc es 346 Suggested Further Reading 346 17. International Banking Learning Objective Objectivess 347 Process of Internationalisation 348 The Financial Intermediation Function 352 Direction and Purposes of Lending 356 Concerns of the Lenders, Borrowers and Depositors 358 The Credit Creation Function 360 Global Cash Management 360 Intermediation in the Foreign Exchange Market 362 Control of International Banks 362 Summary 364 C ASE STUDY ABN AMRO B ANK AND CORRESPONDENT B ANKING Review Questions 365 References Referenc es 366 Suggested Further Reading 367 18. International Financial Market Instruments Learning Objective Objectivess 368 International Equities 368 International Bonds 371 Secondary Market Operation of International Securities Gains from International Issues 378 Short-term and Medium-term Instruments 379 Summary 381 382 STUDY TOPIC EURO -ISSUES OF THE I NDIAN FIRMS Review Questions 385 References Referenc es 386 Suggested Further Reading 387 19. Financial Swaps Learning Objective Objectivess 388 Interest-Rate Swap 389 Currency Swap 393 Equity Swap 397 Some Aspects of Swap Management Swaps in India 400 Summary 401 Review Questions 402 Suggested Further Reading 403
3 25 –3 46
341
34 7 –3 67
IN
INDIA
365
3 6 8 –387
377
38 8– 4 03
398
Contents
20. Management of Interest-Rate Risk Learning Objective Objectivess 404 Nature of Interest-Rate Exposure 405 Bond Yield, Term Structure and Interest-Rate Risk 406 Techniques of Managing Interest-Rate Exposure 409 Summary 419 GREEMENTS (FRA S) IN INDIA STUDY TOPIC FORWARD R ATE A GREEMENTS 419 Review Questions 421 Referencee Referenc 423 Suggested Further Reading 423
Partt 6 Par
xiii
40 4–4 23
Manag Ma nageme ement nt of Sho Shortrt-ter term m Fun Funds ds
21. International Working Capital Management Learning Objective Objectivess 427 Working Capital Policy 428 Basics of Managing Cash and Near-cash Assets 430 Steps in Management of Cash and Near-cash Assets 434 Management of Receivables 442 Management of Inventory 444 Financing of Current Assets 445 Summary 447 Review Questions 448 Referencee Referenc 449 Suggested Further Reading 449
42 7 –4 49
22. Financing of Foreign Trade Learning Objective Objectivess 450 Foreign Trade Documentation 450 Modes of Payment in International Trade 454 Methods of Trade Financing 455 Export-Import Bank of India 462 Summary 463 C ASE STUDY FORFAITING A GREEMENT GREEMENT BETWEEN G HANA COMMERCIAL B ANK AND V IKAS IKAS INTERNATIONAL 464 Review Questions 466 References Referenc es 467 Suggested Further Reading 467
4 50 –4 67
Part Pa rt 7
Misc Mi scel ella lane neou ous s Iss Issue ues s
23. International Accounting Learning Objective Objectivess 471 Globalisation of the Concept of Accounting 471 Consolidation of Financial Statements 473 Accounting of Foreign Currency Translat Translation ion 477 Accounting for Inflation Inflationary ary Trends 479
47 1 –4 94
xiv
Contents
Analysing Foreign Financial Statements Transfer Pricing 482 Summary 491 Review Questions 491 References Referenc es 493 Suggested Further Reading 494 24.
481
International Indebtedness
495–513
Learning Objective Objectivess 495 External Resources and Development 496 Nature and Magnitude of External Debt 498 Factors Behind the Debt Crisis 500 Management of External Indebtedness 503 Challenges Ahead 508 Summary 509 C ASE STUDY INDIA ’S GROWING E XTERNAL INDEBTEDNESS Review Questions 511 References Referenc es 512 Suggested Further Reading 513 25.
International Taxation
Learning Objective Objectivess 514 Bases of International Tax System 515 Types of Taxes 516 Tax Havens 517 Modes of Double Taxation Relief 519 International Tax Management Strategy Indian Taxation Scenario 521 Summary 525 Review Questions 525 References Referenc es 526 Suggested Further Reading 526
509
514–526
520
Glo ss ary
52 7 – 5 40
Country and Currency
54 1 – 5 42
Answers to Objective Type Questions
54 3 – 5 45
Answers to Numerical Problems
54 7 – 5 49
Author Index
55 1 – 5 53
Subject Index
55 5 – 5 58
Preface
International finance is a subject where changes and developments are very fast. It needs to be updated. Thus, the primary purpose of the sixth edition is to acquaint the readers with the developments that have occurred after the last edition had come out. It is not simply updating of the subject. The study on international financial crisis has been expanded in view of the growing relevance of such crises for the Indian economy. The discussion has been elaborated in many other chapters in order to create greater interest of the readers in the subject. A number of boxes have been added to the main discussio discussion n so that the readers could grasp the term more intensively or they could correlate the theory with the real world developments. Last but not least, some case studies/study topics have been inserted that are more relevant in the present-day world. I am sure the readers will find the new edition highly useful. Vyuptakesh Sharan
xv
Preface to the First Edition
With the growing acceptance of the policy of economic liberalisation and globalisation, there has been fast expansion in international trade, in the activities of the multinational corporations and in the international financial market. Recent times have witnessed remarkable growth in international transactions. transactions. To handle these transactions effectively, it is imperative to have qualified and trained personnel. In fact, this is one of the main reasons that the subject of international financial management has gained importance in the area of international financial dealings and in the curricula of business management courses all over the world and especially in the developing countries. I have been teaching this subject not only at the Jawaharlal Nehru University (JNU), New Delhi, but I have also been delivering lectures on it at different institutions in the country as a visiting faculty. It is my students at different institutions who insisted and motivated me to write a textbook on this subject. So, the credit for this text goes to them. Today, we find that though there are a few good textbooks on this subject, they lack some of the important perspectives of the developing countries. My effort has been to fill this gap and to shape this book to suit the interests of the readers of both the developed and the developing countries. I have tried to include almost all the topics that have been covered by the existing textbooks and to make the explanation lucid and intelligible even to a general reader who does not necessarily have a strong background of economics or commerce. The size of the book has been kept reasonable since the business management students get less than a month for one course on an average. If any student likes to delve deeper into a particular topic, he or she can do so through the Suggested Reading at the end of each chapter. Quite a number of people—my colleagues and others—have helped me considerably during the preparation of this manuscript. I am grateful to Prof. I.N. Mukherji of the Jawaharlal Nehru University, and Prof. R.S. Nigam, Prof. Y.P. Singh and Prof. D.P.S. Varma of the Delhi School of Economics Economics,, Universi University ty of Delhi, for their useful suggestio suggestions. ns. xvii
xviii
Preface to the First Edition
I also wish to express my sincere thanks to my wife for the inspiration and encouragement she has provided for preparing this book. I am sure, the readers will find this book both interesting and useful. Nevertheless, I expect comments from them in order to make the next edition still more useful. Vyuptakesh Sharan
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