Scope of International Finance
Increasing Interdependence in the Global Economy
Financial management of a company is a complex process, involving its own methods and procedures. It is made even more complex because of the globalization taking place, which is making the world’s financial and commodity markets more and more integrated. The integration is both across countries as well as markets. Not only the markets, but even the companies are becoming international in their operations and approach. This changing scenario makes it imperative for a student of finance to study international finance.
When a firm operates only in the domestic market, both for procuring inputs as well as selling its output, it needs to deal only in the domestic currency. As companies try to increase their international presence, either by undertaking international trade or by establishing operations in foreign countries, they start dealing with people and firms in various nations. Since different countries have different domestic currencies, the question arises as to which currency should the trade be settled in. The settlement currency may either be the domestic currency of one of the parties to the trade, or may be an internationally accepted currency. This gives rise to the problem of dealing with a number of currencies. The mechanism by which the exchange ratebetween these currencies (i.e., the value of one currency in terms of another) is determined, along with the level and the variability of the exchange rates can have a profound effect on the sales, costs and profits of a firm. Globalization of the financial markets also results in increased opportunities and risks on account of the possibility of overseas borrowing and investments by the firm. Again, the exchange rates have a great impact on the various financial decisions and their movements can alter the profitability of these decisions.
In this increasingly globalize scenario, companies need to be globally competitive in order to survive. Knowledge and understanding of different countries’ economies and their markets is a must for establishing oneself as a global player. Studying international finance helps a finance manager to understand the complexities of the various economies. It can help him understand as to how the various events taking place the world over are going to affect the operations of his firm. It also helps him to identify and exploit opportunities, while preventing the harmful effects of international events. A thorough understanding of international finance will also assist the finance manager in anticipating international events and analyzing their possible effects on his firm. He would thus get a chance to maximize profits from opportunities and minimize losses from events which are likely to affect his firm’s operations adversely.
Companies having international operations are not the only ones, which need to be aware of the complexities of international finance. Even companies operating domestically need to understand the issues involved. Though they may be operating domestically, some of their inputs (raw materials, machinery, technological know-how, capital, etc.) may be imported from other countries, thus exposing them to the risks involved in dealing with foreign currencies. Even if they do not source anything from outside their own country, they may have foreign companies competing with them in the domestic market. In order to understand their competitors’ strengths and weaknesses, awareness and understanding of international events again gains importance.
What about the companies operating only in the domestic markets, using only domestically available inputs and neither having, nor expecting to have any foreign competitors in the foreseeable future? Do they need to understand international finance? The answer is in the affirmative. Globalization and deregulation have resulted in the various markets becoming interlinked. Any event occurring in, say Japan, is likely to affect not only the Japanese stock markets, but also the stock markets and money markets the world over. For e.g., the forex and money markets in India have become totally interlinked now. As market players try to profit from the arbitrage opportunities arising in these markets, the events affecting one market also end up affecting the other market indirectly. Thus, in case of occurrence of an event which has a direct effect on the forex markets only, the above mentioned domestic firm would also feel its indirect effects through the money markets. The same holds good for international events, thus, the need for studying international finance.
Trends in International Trade and Cross Border Financial Flows
Globalization essentially involves the various markets getting integrated across geographical boundaries. Integration of financial markets involves the freedom and opportunity to raise funds from and to invest anywhere in the world, through any type of instrument. Though the degree of freedom differs from country to country, the trend is towards having a reducing control over these markets. As a result of this freedom, anything affecting the financial markets in one part of the world automatically and quickly affects the rest of the world also. This is what we may call the Transmission Effect. Higher the integration, greater is the transmission effect.
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