IBO 06
International Business Finance
IGNOU IBO 06 Solved Free Assignment
IBO 06 Solved Free Assignment July 2023 & January 2024
Q. 1. (a) What do you understand by international cash management. Discuss its need and importance.
Ans. The basic objective of cash management is to reduce the operating cash requirements to the minimum possible extent without affecting the routine transactions.
Float indicates the difference between the bank balance as per bank book and as per the bank pass/book/bank statement. Today it has become important for firms to engage in international cash management.
Cash management like any other function can be explained from two perspectives: intracountry and intercountry perspective.
The key conceptual difference between them is Foreign exchange.
The objectives, thus, of effective working management (of which cash management is an important component) in an international environment are to allocate short-term investments and cash balance holdings between currencies and countries to maximize overall corporate returns and to borrow in different money markets to achieve the minimum cost.
These objectives are to be pursued under the conditions of maintaining required liquidity and minimizing any risks that may be incurred.
Management of cross border or inter-country cash flows involves integrating cash and foreign exchange management.
This also include the questions of local versus head office management of working capital and how to minimize foreign exchange transactions costs, political risks and taxes.
As with every other corporate activity, cash management begins with the Planning. The corporate long-term strategic plan and the annual business plan result in the preparation of budgets for each department.
Along with a global perspective of cash management arise an expanded concept of the cash manager. Unbundling of funds or transfers of funds are also being kept in mind.
International banking and international cash management go hand in hand. Banks are also focusing more on their international payment systems and cash management services.
(b) Explain the importance of cash cycle in cash management.
Ans. International cash management is most easily viewed within the context of the overall cash cycle.
Any cash cycle depends on the cash programmes that are designed in a firm. Well-designed cash programmes follow a few simple ground rules given below:
There is a cash management center that receives and distributes timely information relating to cash movements on a number of bank accounts strategically placed to serve the needs of the company’s operating divisions.
Information is distributed on the basis of a need to know which is different from cash requirements.
Short payment channels involving a minimum number of banks allow for maximum control.
Modern communication systems are used.
Efficient banks with high standards of customer service are employed.
There is a minimal impact on the internal corporate organisation, decision making pattern and accounting system.
With these ground rules in mind, cash management is divided into four areas: collection, disbursement, inter-company payments and control.
The cash cycle begins on the collection side with a customer transaction. Mere, the float management objective is to accelerate receipts.
Once funds are deposited and available for use, the objective is to control balance levels, maximizing cash available to reduce borrowings or increase investments.
If the currency of collection is different from the currency of disbursement, a foreign exchange transaction is necessary.
The objective in this part of the cash cycle is to identify and manage resulting foreign exchange :xposures. On the disbursement side, the objective is to control the float.
Q. 2. What are the factors for determining centralisation and decentralisation of exchange risk management. Discuss the policies you would advocate for Indian multinationals with suitable examples.
Ans. Centralization or decentralization is a predominantly significant concern in exchange risk management. The selection depends not only on the company’s management style, but also on the nature of its business.
In any case, the logistics of management manipulate handling of currency risk in a variety of ways. In the area of foreign exchange risk management handling of currency risk is in a variety of ways.
In the area of foreign exchange there are good arguments for both and against centralization.
Favouring centralization is the reasonable assumption that local treasurers want to optimize their own financial and exposure positions regardless of the overall corporate situation.
Many companies take the view that their group’s commercial success requires strong local control.
The concept of centralization, even though with the rapidly changing face of the corporate culture, has still maintained its importance for many organizations, which abide by the very approach and consider it a means of their success.
Centralization is basically a suitable option for all those organizations and enterprises that have the following
characteristics:
The size of the organization is large in terms of personnel. Along with a great team of personnel, the capital investment of the organization is also enormous.
Regarding the nature of the environment, the work environment in an organization that employs the approach of centralization is a highly competitive one.
In addition to that, a lot of importance is given to brand name, patent rights and the sorts. The product lines are homogeneous. Moreover the level of interdependence between various departments is also very high.
These are the major characteristics that form the basis of a centralized organization.
The term “decentralization” embraces a variety of concepts which must be carefully analyzed in any particular country before determining if projects or programme should support reorganization of financial system.
But decentralization is not a panacea, and it does have potential disadvantages. Decentralization may not always be efficient, especially for standardized, routine, network-based services.
It can result in the loss of economies of scale and control over scarce financial resources by the central government.
Multinational corporations like India, have to decide on the degree of centralization of their exchange risk management function. In a totally decentralized system, each corporate unit is responsible for managing its own exposure.
In a fully centralized system, risk management is the sole responsibility of the corporate centre. As has already been mentioned, centralized risk management offers certain advantages.
It is possible to balance out long and short positions and to calculate the group-wide net position for each currency. Only these net exposures need to be hedged in the derivatives markets.
Furthermore, centralization allows the firm to benefit from economies of scale (larger overall positions, employment of specialized know-how, access to international financial markets).
On the other hand, the introduction of a centralized risk management system may be costly, and it may meet with resistance by the management of the local subsidiaries.
In addition, the firms have to take into account capital controls and other legal restrictions which in some countries may impose limitations on the centralization of exchange risk management.
Centralization and decentralization are not “either-or” conditions. In most countries an appropriate balance of centralization and decentralization is essential to the effective and efficient functioning of government.
Not all functions can or should be financed and managed in a decentralized fashion.
Q. 3. Comment on the following:
(a) “Devaluation is the least effective remedy for correcting an adverse BOP situation.
Ans. Devaluation is a reduction in the value of a currency with respect to other monetary units.
In common modern usage, it specifically implies an official lowering of the value of a country’s currency within a fixed exchange rate system, by which the monetary authority formally sets a new fixed rate with respect to a foreign reference currency.
Devaluation is most often used in situations where a currency has a defined value relative to the baseline.
In an open market, the perception that devaluation is imminent may lead speculators to sell the currency in exchange for the country’s foreign reserves, increasing pressure on the issuing country to make an actual devaluation.
When speculators buy out all of the foreign reserves, a balance of payments crisis occurs.
In practice, the onset of crisis typically occurs after the real exchange rate has depreciated below the nominal rate.
The reason for this is that speculators do not have perfect information; they sometimes find out that a country is low on foreign reserves well after the real exchange rate has fallen.
In these circumstances, the currency value will fall very far very rapidly.
(b) Change in exchange rates have radical impact on patters of international trade and capital flows.
Ans. Exchange rates are clearly influenced by a wide range of economic factors, and the importance of each varies both from country to country and, for any given currency, over time.
Income generated from activities outside of the company/country is considered as External income.
It broadly encompasses all outside business activities, such as the sale of products or services.
So, in a case where growth rate of external income is higher in India than in Japan, this would mean depreciation of Japanese currency as compared to Indian rupee.
Typically, a currency will lose value or will depreciate if there is a high level of inflation in the country or if inflation levels are perceived to be rising.
So, in this case Indian rupee will depreciate. This is because inflation erodes purchasing power, thus demand, for that particular currency.
However, a currency may sometimes strengthen when inflation rises because of expectations that the Central Bank will raise short-term interest rates to combat rising inflation.
(c) FDI do not saves time and transporation cost.
Ans. The rationale of FDI may be based on that it saves time and transport cost. Some of the (relatively) less efficient MNCs in economic terms may come to command clout on account of political geographical, racial and other exterior considerations. While transport costs.
labour costs. time and interest costs are important. the real life story (success or failure) may be different from the economic rationale as anticipated.
In fact, a less efficient foreign player may have greater chance of getting guaranteed return and such other benefits from the government and business doyens in a host country.
(d) Tax policy has no impact on foreign investment.
Ans. The tax policy influences investment decisions through its effects on the cost of capital and returns to different activities.
Tax policies influence Investment decisions of multinational firms through a complicated interaction of home-and-host country taxation and differences across countries in the treatment of debt and equity finance.
Foreign subsidiaries of U.S. firms that are financed by parent equity generally face higher costs of capital than do local firms in foreign markets.
The cost of capital is affected not only by the pre-tax financial costs but also by parameters in “home” (residence) and “host” (source) countries, such as tax-incentives created by the host-country’s tax rates, investment incentives and depreciation rules, and variation (over time and across firms) in the tax costs of repatriated dividends of foreign subsidiaries.
The tax rates can affect investment. Each percentage point increase in the cost of capital reduces by 1-2 percentage points a subsidiary’s rate of investment.
Here the rate of investment is measured by the investment during the year divided by the beginning of the year capital-stock.
The rate of investment is considered along with the tax policy, not the decision to invest or not.
Q. 4. Distinguish between:
(a) Primary holding company and Intermediate holding company.
Ans. Legally, we can also define a holding company (holding corporation) as the one which holds major ownership interest (51 per cent) in another company which is called the subsidiary company (Subsidiary Corporation).
Commercially (in an operational sense), multinational corporation may be able to reap the major benefits of holding company control even with small minority stakes.
In this process, the number of (directly or indirectly) controlled companies grows by geometric progression.
Thus if, in the first stage, the primary holding company controls three intermediate holding companies, the latter, in their turn (second stage), would be able to control another nine companies, presuming that three companies are controlled by each intermediate holding company.
Hence, a primary holding company is defined as a company which controls another company (or companies) but which, itself, is not controlled by any other company; it stands at the head (Apex).
(b) Amalgamation and Merger.
Ans. A merger has been defined as the fusion or absorption of one thing or right into another.
It may also be understood as an arrangement, whereby the assets of two (or more) companies become vested in, or under the control of one company (which may or may not be one of the original two companies) which has as its shareholders all or substantially all, the shareholders of the two companies.
In other words, in a merger one of the two existing companies merges its identity into another existing company or one or more existing companies may form a new company and merge their identities into a new company by transferring their businesses and undertakings including all other assets and liabilities to the new company (hereinafter referred to as the merged company).
The term “amalgamation” contemplates two or more companies deciding to pool their resources to function either in the name of one of the existing companies or to form a new company to take over the businesses and undertakings including all other assets and liabilities of both the existing companies.
The shareholders of the existing companies (known as the amalgamating companies) hold substantial shares in the new company (referred to as the amalgamated company).
They are allotted shares in the new company in lieu of the shares held by them in the amalgamating companies according to share exchange ratio incorporated in the scheme of amalgamation as approved by all or the statutory majority of the shareholders of the companies in their separate general meetings and sanctioned by the court.
In other words, in amalgamation, the undertaking comprising property, assets and liabilities of one or more companies are taken over by another or are absorbed by and transferred to an existing company or a new company.
(c) Discounted cash flow and Non-Discounted cash flow techniques.
Ans. Over the years, businesses have evolved various techniques of project appraisal. Non-DCF and DCF are the two broad groups. DCF means Discounted Cash Flow.
The main difference between non-DCF and DCF techniques is that while non-DCF techniques use undiscounted or unadjusted for time value of money cash flow data, the DCF techniques use discounted or adjusted for time value of money cash flows.
The time value of money is a very critical concept in project appraisal. Time value of money increase a rupee today is worth more than a rupee tomorrow.
Payback period and Accounting Rate of Return are the two techniques of project appraisal belonging to the non-DCF group.
Net Present Value (NPV) and the Internal Rate of Return (IRR) are the two popular DCF techniques of project appraisal.
(d) Dividend valuation model and Capital asset pricing model.
Ans. Dividend valuation model is a mathematical formula used generally by stockbrokers to put a price on a firm’s shares, based on the firm’s potential dividend level.
Even in the case of the dividend valuation model, the expectations of future earnings can be reliable, only if the new project has a similar risk profile and financial structure to that of existing projects.
Equity returns are calculated as the sum of the dividend yield and the expected growth in dividends; the calculation therefore looks at the ‘fundamentals’ affecting shareholders’ perceptions of value.
In practice, however, there are difficulties in assessing the appropriate assumptions on dividend growth: dividend growth for a particular company or sector in the past may not be a good predictor for future expectation.
A model that describes the relationship between risk and expected return and that is used in the pricing of risky securities.
The capital asset pricing model (CAPM) is an economic model for valuing stocks, securities, derivatives and/or assets by relating risk and expected return.
CAPM is based on the idea that investors demand additional expected return (called the risk premium) if they are asked to accept additional risk.
The CAPM model says that this expected return that these investors would demand is equal to the rate on a risk-free security plus a risk premium.
If the expected return does not meet/beat the required return, the investors will refuse to invest and the investment should not be undertaken.
Q. 5. Write short notes on the following:
(a) International money transfer mechanism.
Ans. International money transfer mechanism is a mode of making payments abroad. This involves dealings with banks operating at the international levels.
Such banks are required to enter through one or more of other organizations like correspondent bank, foreign branch, foreign agencies, foreign subsidiary banks, representative offices etc.
Also, at times such banks are required to open an existing branch in a foreign nation.
Banks located all over the world are said to be the centre for money transfer business.
The people using such source of payment transfer are generally the dealers in securities or the exporters/importers who need to know the way to finance their import or export activities and the way to get paid, especially when trading in foreign currencies.
Finding a bank that is comfortable and proficient in providing the various products and services required by exporting and importing firms is becoming easier as international sales become more and more common.
International banking business may be done via following international organizations: Correspondent bank, foreign branch, foreign agencies, foreign subsidiary bank, and representative offices.
The transfer of amount from the payer to the payee affects the devastating majority of the payments by sending instructions in the form of written transfer orders, cheques, phone, telegraphic instructions, or advanced computer signals through complex networks.
Thus, it is mandatory for every person who is trying to make transfers from one country to another to firstly obtain ownership of the demand deposit in a bank in a foreign country in a direct or indirect way.
This ownership is then consequently transferred to payee of the funds.
Since, there’s not much need for any corporation to maintain current accounts in foreign country. And major banks hence, maintain their demand deposit accounts with their foreign correspondent banks located overseas.
To assist the business dealings of another bank in any other bank located at a different place, these banks are chosen.
Resources are made on hand in the existing account of overseas bank with the correspondent bank. The correspondent bank will then make an expense to the relevant payee after receiving instructions from the overseas bank.
Further the economics of clearing and the blueprint of account correlation have also affected foreign exchange trading practices. And thus, there are two types of accounts in international banking world.
They are nostro and vostro accounts. A vostro (means your) account is another bank’s account with a reporting bank, while a nostro (means our) account is a reporting bank’s account with another bank.
Nostro and vostro are the accounting terms used to differentiate an account you hold for another entity from an account another entity holds for you.
Clearing house payment system (CHPS) is an advanced technology used in for money transfers by international banks making Dollar payments.
(b) Repurchase agreements.
Ans. Repurchase agreements (RPs or repos) are known as financial instruments used in money markets and capital markets.
Typical repurchase agreements has a borrower (seller/cash receiver) to sell securities for cash to a lender (buyer/cash provider) and who agrees to repurchase those securities at a later date for more cash.
This repo rate is the difference between borrowed and paid back cash expressed as a percentage.
A repo is economically similar to a secured loan, with the buyer receiving securities as collateral to protect against default.
There is little that prevents any security from being employed in a repo; so, Treasury or Government bills, corporate and Treasury/Government bonds, and stocks/shares, may all be used as securities involved in a repo.
(c) Currency derivatives market in India.
Ans. The global market for derivatives has grown substantially in the recent past. However, the financial markets for forward and spot currency are well developed in India against future and options market.
This tremendous growth in global derivative markets can be attributed to a number of factors.
They reallocate risk among financial market participants, help to make financial markets more complete, and provide valuable information to investors about economic fundamentals.
Derivatives also provide an important function of efficient price discovery and make unbundling of risk easier.
In India, the economic liberalization in the early nineties provided the economic rationale for the introduction of FX derivatives.
Business houses started actively approaching foreign markets not only with their products but also as a source of capital and direct investment opportunities.
With limited convertibility on the trade account being introduced in 1993, the environment became even more conducive for the introduction of these hedge products.
Hence, the development in the Indian forex c should be seen along with the steps taken to gradually reform the Indian financial markets.
Also, RBI is putting constant efforts for nudging banks to deal with derivatives. An important segment of the forex derivatives market in India is the Rupee forward contracts market.
This has been growing rapidly with increasing participation from corporate, exporters, importers and banks.
(d) Business environment risk index.
Ans. There are two approaches to measure the political risk. Firstly, there is the country-specific route (called the macro approach), and secondly, one can take the firm specific route (called the micro-approach).
An index that tries to include political, economic and country related subjective factors is called Business Environment Risk Index (BERI).
A method similar to BERI is that of the financial magazine “Euro money”. Its monthly country-risk evaluation is based on the weighting given to various factors.
For a business, the implication for political risk is that there is a measure of likelihood that political events may complicate its pursuit of earnings through direct impacts (such as taxes or fees) or indirect impacts (such as opportunity cost forgone).
As a result, political risk is similar to an expected value such that the likelihood of a political event occurring may reduce the desirability of that investment by reducing its anticipated returns.
At the macro level, political risk mitigation largely involves understanding political uncertainties of the operating environment and the risks faced by all business operations in individual countries.
Such information can come in the form of customized analysis or in-depth subject matter reporting; information that can enable an investor or firm to calibrate their risk appetite. Mitigation tactics involve both macro- and micro-level strategies.