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International business refers to the trade of goods, services, technology, capital and/or
knowledge across national borders and at a global or transnational scale.

It involves cross-border transactions of goods and services between two or more countries.
cont’d

➢International business" is also defined as the study of the internationalization process of

multinational enterprises

➢ A multinational enterprise (MNE) is a company that has a worldwide approach to

markets, production and/or operations in several countries
E,g Cont’d
Well-known MNEs include fast-food companies
such as: McDonald's (MCD), YUM (YUM), Starbucks Coffee Company (SBUX), Microsoft
(MSFT), Ford Motor Company, and General Motors (GMC), Samsung, LG and Sony, and
energy companies such as Exxon Mobil, and British Petroleum

WHY STUDY INTERNATIONAL FINANCE

• The emergence and rise of multinational companies has resulted in high levels of international
business activities
• The emergence and rise of multinational companies has resulted in high levels of
international business activities.

• International business encompasses commercial

transactions like sales, investment and transportation between two or more companies.

Meaning of International Finance

➢International finance is an area of financial economics that deals with monetary

interactions between two or more countries concerning itself with the topics such as
currency exchange rates, international monetary system

Scope of International Finance

• Foreign exchange markets

• Exchange rates
• Multinational financial system
• Risk management floating exchange rate
• International accounting – consolidation International Financial Management
• Multinational vs. domestic financial
management
• Exchange rates and trading in foreign
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exchange
• International money and capital markets
What is a multinational corporation?
• A corporation that operates in two or more
countries.
• Decision making within the corporation may be centralized in the home country, or may be
decentralized across the countries the corporation does business in.
Why do firms expand into other
countries?

• To seek new markets. • To avoid political and regulatory hurdles.

• To seek raw materials. • To diversify.
• To seek new technology. • To retain customers.
• To seek production efficiency. • To protect processes.

What factors distinguish multinational financial

management from domestic financial
management?

➢Different currency denominations.

➢Political risk
➢Economic and legal ramifications.
➢Role of governments Language and cultural

differences.
Methods of International Business
✓ EXPORTING
✓ FRANCHISING
✓ LICENSING
✓ JOINT VENTURING
✓ COUNTER TRADE
✓ CONTRACT MANUFACTURING
✓ MERGERS & ACQUISITIONS
✓ THIRD COUNTRY LOCATION
Example – export or import

Theories of IB
• Mercantilism.
• Absolute Advantage.
• Comparative Advantage.
• Product Life Cycle Theory.
• Global Strategic Rivalry Theory.
• National Competitive Advantage Theory

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1.Mercantilism
• Initial trade theory that formed the

foundation of economic thought from 1500 imports

– • It was also advantageous to run a trade
1800 surplus with “colonies”
• Based on concept that a nations wealth Mercantilism
is • Favorable balance of trade:
measured by its holding of treasure (gold) country is exporting more than it
• Nations often imposed restrictions on is importing
imports • Unfavorable balance of trade:
since they did not want “their” treasure country is importing more than it
moving to another country to pay for the is exporting, i.e. a trade deficit

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 CHAPTER 2

FOREIGN EXCHANGE MARKET

 foreign exchange market allows for the exchange of one currency for another

 Large commercial banks serve this market by holding inventories of each currency so
that they can accommodate requests by individuals or MNCs

 For one currency to be exchanged for another currency, an exchange rate is needed that
specifies the rate at which one currency can be exchanged for another

By 1971 the U.S. dollar had apparently become overvalued; the foreign demand for U.S. dollars
was substantially less than the supply of dollars for sale (to be exchanged for other
currencies)

Representatives from the major nations met to discuss this dilemma. As a result of this
conference, which led to the Smithsonian Agreement, the U.S. dollar was devalued relative to
the other major currencies.

FOREIGN EXCHANGE TRANSACTIONS

 The largest foreign exchange trading centers are in London, New York, and Tokyo, but
foreign exchange transactions occur on a daily basis in cities around the world

 The average daily trading volume in the foreign exchange market is about $4 trillion.
The U.S. dollar is involved in about 40 percent of those transactions

Bid/Ask Spread of Banks

 Commercial banks charge fees for conducting foreign exchange transactions; thus, they
buy a currency from customers at a slightly lower price than the price at which they sell it

 This means that a bank’s bid price (buy quote) for a foreign currency will always be less
than its ask price (sell quote).

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Direct versus Indirect Quotations at One Point in Time

Direct Quote

Quotations that report the value of a foreign currency in dollars (number of dollars per unit of
other currency) are referred to as direct quotationse.g. 1ETB/$ = Number of dollars per unit
of ETB

1ETB/40= 0.025

FORWARD CONTRACTS

is an agreement between an MNC and a foreign exchange dealer that specifies the currencies to
be exchanged, the exchange rate, and the date at which the transaction will occur- traded over
the counter

Currency Futures Contracts

 specifies a standard volume of a particular currency to be exchanged on a specific

settlement date. Traded on an exchange

Currency Options Contracts

 Currency options contracts can be classified as calls or puts.

 A currency call option provides the right to buy a specific currency at a specific price
(called the strike price or exercise price) within a specific period of time. It is used to
hedge future payables.

 A currency put option provides the right to sell a specific currency at a specific price
within a specific period of time

 Arbitrage can be loosely defined as capitalizing on a discrepancy in quoted prices by

making a riskless profit

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 Types of Arbitrage

a. Locational arbitrage

b. Triangular arbitrage

c. Covered interest arbitrage

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 Chapter 3

International Parity

MEASURING EXCHANGE RATE MOVEMENTS

 As economic conditions change, exchange rates can change substantially

 A decline in a currency’s value is known as depreciation ( devaluation)

 An increase in currency value is known as appreciation

 When a foreign currency’s spot rate at two different times are compared, the spot rate at
the more recent date is denoted S and the spot rate at the earlier date is denoted as St−1

 The percentage change in the value of the foreign currency is then computed as follows

Change in exchange rate = St-1- S/St-1

 Recall that an exchange rate (at a given time) represents the price of a currency, or the
rate at which one currency can be exchanged for another

 The exchange rate always involves two currencies, but the focus in this text is the U.S.
perspective

Demand for a Currency

 Demand schedule is downward sloping

Example: there is U.S. demand for pounds due to international capital flows, as U.S. firms
and investors obtain pounds to invest in British securities

Managed Float Exchange Rate System

 The exchange rate system that exists today for most currencies lies somewhere between
fixed and freely floating

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  Most large developed countries allow their currencies to float, although they may be
periodically managed by their respective central banks

ΔINC - change in the differential between the U:S: income level and the foreign country’s
income level

ΔGC - change in government controls

ΔEXP - change in expectations of future exchange rates

5. Unbiased Forward Rate Theory

Five Parity Conditions

1. Interest Rate Parity Theory EXCHANGE RATE SYSTEMS

2. Purchasing Power Parity Theory  Fixed,

3. The Fisher Effect  Freely floating,

4. International Fisher Effect  Managed float, or

 Pegged.

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 Chapter 4

Management of Foreign Exchange Exposure

 Exchange rates are extremely volatile. As a result, the dollar value of an MNC’s future
payables or receivables position in a foreign currency can change substantially in response to
exchange rate movements

Although some arguments suggest that an MNC’s exposure to exchange rate risk is irrelevant

 There different Arguments

1. The Investor Hedge Argument

This argument assumes that investors have complete information on corporate exposure to
exchange rate fluctuations as well as the ability toinsulate their individual exposure

Currency Diversification Argument

 Another argument is that, if a U.S.-based MNC is well diversified across numerous

countries, then its value will not be affected by exchange rate movements because of
offsetting effects

Stakeholder Diversification Argument

 Some have argued that if stakeholders (such as creditors or stockholders) are well
diversified then they will be sufficiently insulated against the losses (due to exchange rate
risk) incurred by any particular MNC

 Yet many MNCs are similarly affected by exchange rate movements, so it is difficult to
construct even a diversified portfolio of stocks that will be insulated from exchange rate
movements

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  Transaction exposure

 Economic exposure

 Translation exposure.

 An MNC creates its financial statements by consolidating all of its individual subsidiaries’
financial statements.

• To be consolidated, each subsidiary’s financial statement must be translated into the

currency of the MNC’s parent. Since exchange rates vary over time, the translation of the
subsidiary’s financial statement into a different currency is affected by exchange rate
movements

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