Components of International Financial Environment

International financial environment is totally different from domestic financial environment. International financial management is subject to several external forces, like foreign exchange market, currency convertibility, international monitory system, balance of payments, and international financial markets.

1. Foreign Exchange Market

Foreign exchange market is the market in which money denominated in one currency is bought and sold with money denominated in another currency. It is an overthe counter market, because there is no single physical or electronic market place or an organized exchange with a central trade clearing mechanism where traders meet and exchange currencies. It spans the globe, with prices moving and currencies trading somewhere every hour of every business day. World’s major trading starts each morning in Sydney and Tokyo, and ends up in the San Francisco and Los-Angeles.

The foreign exchange market consists of two tiers: the inter bank market or wholesale market, and retail market or client market. The participants in the wholesale market are commercial banks, investment banks, corporations and central banks, and brokers who trade on their own account. On the other hand, the retail market comprises of travelers, and tourists who exchange one currency for another in the form of currency notes or traveler cheques.

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2. Currency Convertibility

Foreign exchange market assumes that currencies of various countries are freely convertible into other currencies. But this assumption is not true, because many countries restrict the residents and non-residents to convert the local currency into foreign currency, which makes international business more difficult. Many international business firms use “counter trade” practices to overcome the problem that arises due to currency convertibility restrictions.

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3. International Monetary System

Any country needs to have its own monetary system and an authority to maintain order in the system, and facilitate trade and investment. India has its own monetary policy, and the Reserve Bank of India (RBI) administers it. The same is the case with world, its needs a monetary system to promote trade and investment across the countries. International monetary system exists since 1944. The International Monetary Fund (IMF) and the World Bank have been maintaining order in the international monetary system and general economic development respectively.

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4. International Financial Markets

International financial market born in mid-fifties and gradually grown in size and scope. International financial markets comprises of international banks, Eurocurrency market, Eurobond market, and international stock market. International banks play a crucial role in financing international business by acting as both commercial banks and investment banks. Most international banking is undertaken through reciprocal correspondent relationships between banks located in different countries. But now a days large bank have internationalized their operations they have their own overseas operations so as to improve their ability to compete internationally. Eurocurrency market originally called as Eurodollar market, which helps to deposit surplus cash efficiently and conveniently, and it helps to raise short-term bank loans to finance corporate working capital needs, including imports and exports. Eurobond market helps to MNCs to raise long-term debt by issuing bonds. International bonds are typically classified as either foreign bonds or eurobonds. A foreign bond is issued by a borrower foreign to the country where the bond is placed. On the other hand Eurobonds are sold in countries other than the country represented by the currency denominating them.

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5. Balance of Payments

International trade and other international transactions result in a flow of funds between countries. All transactions relating to the flow of goods, services and funds across national boundaries are recorded in the balance of payments of the countries concerned.

Balance of payments (BoPs) is systematic statement that systematically summarizes, for a specified period of time, the monetary transactions of an economy with the rest of the world. Put in simple words, the balance of payments of a country is a systematic record of all transactions between the ‘residents’ of a country and the rest of the world. The balance of payments includes both visible and invisible transactions. It presents a classified record of:

  1. All receipts on account of goods exported, services rendered and capital received by ‘residents’ and
  2. Payments made by then on account of goods imported and services received from the capital transferred to ‘non-residents’ or ‘foreigners’.

Thus the transactions include the exports and imports (by individuals, firms and government agencies) of goods and services, income flows, capital flows and gifts and similar one-sided transfer of payments. A rule of thumb that aids in understanding the BOP is to “follow the cash flow”. Balance of payments for a country is the sum of the Current Account, the Capital Account, and the change in Official Reserves.

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Credit: International Business Finance-CU