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

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