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INTERNATIONAL BUSINESS

UNIT-I

International Business Environment, Trends in International Trade, Needs for Going Internationa

International Marketing, Economic Growth and its impact on the International Business.

International Business Environment

Concept of International Business:- 

Introduction : International business has been playing a crucial role for centuries. In the present d

world it has become indispensable for any country. Its role has increased in significance, both at th

macroeconomic and microeconomic levels. No country developed or developing produces a

commodities to meet its requirements. It needs to import items that are not produced domestically. A

the same time, it tries to export all items that are produced over and above its domestic requirements.

Meaning of International Business : International business means carrying on business activiti

 beyond national boundaries. These activities normally include transaction of economic resources suas:

o  Goods

o  Capital

o  Services (comprising technology, skilled labour and transportation, etc.)

o  International production.

Production may either involve production of physical goods or provision of services like bankin

finance, insurance, construction, trading and so on. Thus international business includes not on

international trade of goods and services but also foreign investment, especially foreign dire

investment.

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Features of International Business Environment

Cultural and social forces in international business

Many of the additional complexities and problems faced by international marketers stem frodifferences in the cultural and social environment which the marketer faces when marketin

internationally. Influences of cultural differences when marketing across national boundaries take on

heightened importance.

We know how people consume, their needs and wants, and the ways in which these wants are satisfi

are determined by culture. Culture is the human-made part of environment that includes knowledg

 beliefs, morals, laws, customs and other elements acquired by humans in society. Because cultures a

so different between countries, cultural forces and factors take on a particular significance for th

international marketer. We highlight some of the possible areas or aspects of culture where there m

 be important differences when marketing in foreign markets:

  social organization;

  norms and values;

  religion;

  language;

  education;

  arts and aesthetics.

Sometimes seemingly relatively small and subtle differences in cultural habits and practices can b

important in marketing products in different cultures. For example, attitudes towards body hair diff

 between even relatively geographically proximate European countries. In the UK for instance, mo

women shave their under-arm hair, whereas most German women do not. A company like Gillette tak

this difference into account in preparing its marketing plans for the different European countries.

Comparison between domestic and international marketing 

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The marketer must understand the implications of these different elements of culture for developin

marketing strategies e.g. there may be very different norms and values pertaining to say gender roles,

the use of sex in advertising when marketing in a foreign country. Similarly, religious beliefs may hav

a significant impact on what is acceptable marketing practice.

It is important to recognize that within any national culture there are often a number of sub-sets

culture. In the UK there is a distinct cultural difference between the north and south, which affec

 purchasing behaviour  – in direct and observable ways, but sometimes in quite subtle ways.

Technological Forces

Technological forces influence organizations in several ways. A technological innovation can have

sudden and dramatic effect on the environment of a firm. First, technological developments ca

significantly alter the demand for an organization's or industry's products or services.

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Technological change can decimate existing businesses and even entire industries, since its shif

demand from one product to another. Moreover, changes in technology can affect a firm's operations

well its products and services.

These changes might affect processing methods, raw materials, and service delivery. In internation

 business, one country's use of new technological developments can make another country's produc

overpriced and noncompetitive. In general,

Technological trends include not only the glamorous invention that revolutionizes our lives, b

also the gradual painstaking improvements in methods, in materials, in design, in applicatio

unemployment, and the transportation and commercial base. They diffusion into new industri

and efficiency" ( John Argenti).

The rate of technological change varies considerably from one industry to another. In electronics, f

example change is rapid and constant, but in furniture manufacturing, change is slower and mo

gradual.

Changing technology can offer major opportunities for improving goal achievements or threaten th

existence of the firm. Therefore, "the key concerns in the technological environment involv

building the organizational capability to

(1) forecast and identify relevant developments - both within and beyond the industry,

(2) assess the impact of these developments on existing operations, and

(3) define opportunities" ( Mark C. Baetz and Paul W. Beamish).

These capabilities should result in the creation of a technological strategy. Technological strategy dea

with "choices in technology, product design and development, sources of technology and R&

management and funding" ( R. Burgeleman and M. Maidique).

Economic Forces

The economic of the host country plays on important role in the decisions of a multination

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organization.

In addition to foreign exchange control policies, the tax structure and the tax policies of the ho

country mus be studied an considered. Some of the economic factors to be considered are:

(a) GNP, income levels of the work force and the proportion of disposable income, saving habits of th

 population, economic growth trends, trends in industrial development, inflation rate, interest rate etc.

(b) Any local financial resources available that would be necessary and helpful in further expanding th

facilities of operation.

(c) Any organized labour unions that could create problems in the from of strikes, demand for high

wages and additional fringe benefits.

(d) Any economic planning agencies that would give the economic trends for the foreseeable futur

India, for example, has five-years plans and sometimes over 10 years and the expected progress over

number of years in the future.

(e) The infrastructure for support services providing for power and water availability,housin

conditions, transportation and communications.

(f) Stability of local currency and its acceptance outside the host country.

If any of these factors makes the operations economically risky, then some steps can be taken to reduc

these risks One way would be to go into a joint venture with local citizens. The joint ventures sprea

the responsibility and the adverse effects are minimized in case of political changes and policy change

Also, they combine the financial and managerial resources of the organization with the needs an

traditional knowledge of the natives and local markets. Some other means of reducing these risks are:

- Entering into licensing agreements only, which require the transfer on technical knowhow for a fixe

fee or continuous royalty for as long as this technical knowledge is utilized.

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- Contracts to manage host country owned installations. This involves leading the managerial talen

with or without the transfer of technical know-how. This id done again by proper compensation f

such services rendered.

- Turn-key operations. In this case the entire project is undertaken by an organization and consists

designing, constructing, developing the unit and training personnel to operate the unit and trainin

 personnel to operate the unit to the point where the key can be turned over to the local owners.

Political and Legal Forces

Political-legal forces include the outcomes of elections, legislation, and court judgments, as well as th

decisions rendered by various commissions and agencies. The political sector of the environme

 presents actual and potential restriction on the way an organization operates.

Among the most important government actions are: regulation, taxation, expenditure, takeover (creatin

a crown corporation, and privatization. The differences among local, national, and internation

subsectors of the political environment are often quite dramatic. Political instability in some are

makes the very form of government subject to revolutionary changes.

In addition the basic system of government and the laws the system promulgates, the politic

environment might include such issues as monitoring government policy toward income tax, relati

influence of unions, and policies concerning utilization of natural resources.

Political activity my also have a significant impact on three additional governmental functio

influencing a firm's external environment:

* Supplier function. Government decisions regarding creation and accessibility of private businessto government-owned natural resources and national stockpiles of agricultural products will profound

affect the viability of some firm's strategies.

* Customer function. Government demand for products and services can create, sustain, enhance,

eliminate many market opportunities.

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* Competitor function. The government can operate as an almost unbeatable competitor in t

marketplace, Therefore, knowledge of government strategies can help a firm to avoid unfavorab

confrontation with government as a competitor.

In general, the impact of government is far-reaching and increasing.

Trends in International Trade

Meaning of World Trade : World trade helps a country to utilize its natural resources and to export

surplus production. It is only because of world trade that oil-exporting countries are utilizing the

natural resources and are able to increase the level of economic development of their countries. Wor

trade helps the country to import technical know-how and thus the importing country can utilize world

 best technology. At the time of natural calamity, a country can import food grains and other goods fro

abroad. World trade has helped the developing and least developed countries to import machiner

capital goods, technical know-how from industrially advanced countries.

Trends in World Trade : Trends in world trade can be analysed in the following manner:

(1)Increase in World's Exports : World's exports have increased significantly. In the year 195

world's exports were only 55 billion dollars and in the year 2004, it has increased to 9,153 billio

dollars. It means that in these 54 years world's exports have increased 166 times. It is clear from thfollowing table:

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The main reason for increase in world's exports is reduction in tariff and non-tariff barriers, multilater

trade, increase in means of communication, transportation, etc.

(2)Top Exporters in Merchandising World Trade : In the year 2004, the largestexporting country

world trade is Germany. Its hare in total world's export is 10 per cent. The top five exporting countri

of the world are:

Germany

USA

China

Japan

France

India's ranking in world's export is 30th. Its share in total world's export is just 0.8 per cent. Da

regarding value of exports, percentage in world's exports and their ranking given in the following table

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(Source: Statistical Outline of India, 2005-06) 

(3)Top Importers in Merchandising (Goods) World Trade : In the year 2004, the largest import

in world trade was U.S.A. Its share in world's imports was 16.1%. India's ranking in world's import

23rd. India's percentage in world' import is just 1.0% The world's five big importers are:

U.S.A.

Germany

China

France

U.K.

(4)World Trade in Services : Services is another area in which world trade is expanding very fa

Service sector mainly includes travel, tourism, banking, insurance, telecommunication, busine

outsourcing (call centres), IT enabled services, consultancy, media-services, software, advertisintransportation, etc.

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(5)Exports of Developing Countries : Among developing countries, the top five countries in wor

trade are:

Hong Kong

Taiwan

Korea

China

Singapore

Their combined share is 50% of exports of all developing countries.

(6)Composition of World Trade : World Trade in terms of product groups comprise

Foodstuff,

Agricultural raw materials,

Fuels,

Ores and metals

Textiles

Chemicals

Machinery

Transport equipment

Gems and jewellery

Computer software

Leather products etc.

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 Nowadays trade in services like banking, software, shipping, telecommunication, travel, tourism etc.

increasing at a faster rate. Presently, World Trade includes engineering goods, capital good

technology, computer software, services, chemicals, along with agricultural goods. So composition

world trade is changing and share of industrial goods and services is expanding at a faster rate, tha

traditional export items.

(7)Growth of Regional Blocs in World Trade : Some of the leading blocs have improved their sha

in world trade. The objective of these blocs is to promote free trade and economic cooperation amon

different regions of globe.

(8)Shift from Bilateral Trade to Multilateral Trade : Earlier, up to the year 1994, world trade w

mainly bilateral. In bilateral trade, agreement is signed between two nations. With the growth in Wor

Trade Organisation, there is shift from bilateral to multilateral trade. In multilateral trade, tra

agreements are signed among many nations at a time.

(9)Shift from Restricted Trade to Free Trade : Earlier, various tariff and non-tariff restrictions we

imposed on world trade. These restrictions were

Import quotas,

Custom duties

Discriminatory transport charges

Voluntary import restraints

Licence system

Subsidies

Commercial prohibition etc.

But now as per the directions of WTO, both tariff and non-tariff barriers to international trade ha

 been reduced. In other worlds, free trade is increasing in the World Trade.

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Needs for going International 

1. Sales Expansion : The main objective of International business is to increase the sale because

international business a firm can sell its product in domestic as well as in foreign market. Man

companies look to international markets for growth. Introducing new products internationally c

expand a company's customer base, sales and revenue. For example, after Coca-Cola dominated th

U.S. market, it expanded their business globally starting in 1926 to increase sales and profits.

2. Resource Acquisition : It means getting the resources from other countries because there may be s

many resources of other country which may not be available in home country.

3. Minimize Competitive Risk  : Many companies move internationally to minimize the risk

competitors. They want to go in international market for defensive reasons.

4. Diversification : Many companies want to diversify the sources of sales and supplies, so they ma

seek foreign market for this purpose.

5.Growth Many companies look to international markets for growth. Introducing new produc

internationally can expand a company's customer base, sales and revenue. For example, after Coca-Co

dominated the U.S. market, it expanded their business globally starting in 1926 to increase sales an

 profits.

Employees Companies go international to find alternative sources of labor. Some companies look

international countries for lower-cost manufacturing, technology assistance and other services in ord

to maintain a competitive advantage 

Ideas Companies go international to broaden their work force and obtain new ideas. A work for

comprised of different backgrounds and cultural differences can bring fresh ideas and concepts to help

company grow. For example, IBM actively recruits individuals from diverse backgrounds because

 believes it's a competitive advantage that drives innovation and benefits customers. 

Advantages of International Business

Increased Socio Economic Welfare : International business enhances consumption level, an

economic welfare of the people of the trading countries. For example, the people of China are no

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enjoying a variety of products of various countries than before as China has been actively involved

international business like Coca Cola, McDonald's range of products, electronic products of Japan an

coffee from Brazil. Thus, the Chinese consumption levels and socio-economic welfare

are enhanced.

Wider Market : International business widens the market and increases the demand for the product

a single country or customer's tastes market size. Therefore, the companies need not depend on t

 preferences of a single country. Due to the enhanced market the Air France, now mostly depends on th

demand for air travel of the customers from countries other than France. This is true in case of most o

the MNCs like Toyota, Honda, Xerox and Coca Cola.

Reduced Effects of Business Cycles : The stages of business cycles vary from country to countrTherefore, MNCs shift from the country, experiencing a recession to the country experiencing 'boom

conditions. Thus international business firms can escape from the recessionary conditions.

Reduced Risks : Both commercial and political risks are reduced for the companies engaged

international business due to spread in different countries. Multinationals, which were operating in

erstwhile USSR, were affected only partly due to their safer operations in other countries. But th

domestic companies of then USSR collapsed completely.

Large Scale Economies : Multinational companies due to the wider and larger markets produce larg

quantities. Invariably, it provides the benefit of large scale economies like reduced cost of productio

availability of expertise, quality etc

Provides the Opportunity for and Challenge to Domestic Business : International business firm

 provide the opportunities to the domestic companies. These opportunities include technolog

management expertise, market intelligence, product developments etc. For example, Japanese firm

operating in US provide these opportunities to US companies. This is more evident in the case developing countries like India, African countries and Asian countries

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International Marketing

International marketing (IM) or  global marketing refers to marketing carried out by compani

overseas or across national borderlines. This strategy uses an extension of the techniques used in t

home country of a firm.[1]  It refers to the firm-level marketing practices across the border includin

market identification and targeting, entry mode selection, marketing mix, and strategic decisions

compete in international markets.[2]  According to the American Marketing Association (AMA

"international marketing is the multinational process of planning and executing the conceptio

 pricing, promotion and distribution of ideas, goods, and services to create exchanges that satis

individual and organizational objectives."[3]  In contrast to the definition of marketing only the wo

multinational has been added.[3] In simple words international marketing is the application of marketin

 principles to across national boundaries. However, there is a crossover between what is commonexpressed as international marketing and global marketing, which is a similar term.

The intersection is the result of the process of  internationalization. Many American and Europe

authors see international marketing as a simple extension of exporting, whereby the marketing mix 4P

is simply adapted in some way to take into account differences in consumers and segments. It the

follows that global marketing takes a more standardised approach to world markets and focuses upo

sameness, in other words the similarities in consumers and segments.

Economic Growth & its Impact on International Business

The issues of international trade and economic growth have gained substantial importance with th

introduction of trade liberalization policies in the developing nations across the world. Internation

trade and its impact on economic growth crucially depend on globalization. As far as the impact o

international trade on economic growth is concerned, the economists and policy makers of th

developed and developing economies are divided into two separate groups.

One group of economists is of the view that international trade has brought about unfavorable chang

in the economic and financial scenarios of the developing countries. According to them, the gains fro

trade have gone mostly to the developed nations of the world. Liberalization of trade policies, reductio

of tariffs and globalization have adversely affected the industrial setups of the less developed an

developing economies. As an aftermath of liberalization, majority of the infant industries in the

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nations have closed their operations. Many other industries that used to operate under governme

 protection found it very difficult to compete with their global counterparts.

The other group of economists, which speaks in favor of globalization and international trade, com

with a brighter view of the international trade and its impact on economic growth of the developin

nations. According to them developing countries, which have followed trade liberalization policie

have experienced all the favorable effects of globalization and international trade. China and India a

regarded as the trend-setters in this case.

There is no denying that international trade is beneficial for the countries involved in trade, if practic

 properly. International trade opens up the opportunities of global market to the entrepreneurs of t

developing nations. International trade also makes the latest technology readily available to th

 businesses operating in these countries. It results in increased competition both in the domestic an

global fronts. To compete with their global counterparts, the domestic entrepreneurs try to be mo

efficient and this in turn ensures efficient utilization of available resources. Open trade policies al

 bring in a host of related opportunities for the countries that are involved in international trade.

However, even if we take the positive impacts of international trade, it is important to consider th

international trade alone cannot bring about economic growth and prosperity in any country. There a

many other factors like flexible trade policies, favorable macroeconomic scenario and political stabili

that need to be there to complement the gains from trade.

There are examples of countries, which have failed to reap the benefits of international trade due to lac

of appropriate policy measures. The economic stagnation in the Ivory Coast during the periods of 198

and 1990s was mainly due to absence of commensurate macroeconomic stability that in turn prevente

the positive effects of international trade to trickle down the different layers of society. Howeve

instances like this cannot stand in the way of international trade activities that are practiced across th

different nations of the world.

In conclusion it can be said that, international trade leads to economic growth provided the polic

measures and economic infrastructure are accommodative enough to cope with the changes in soci

and financial scenario that result from it.

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UNIT-II

Political, Legal and Cultural Environment: Impact of economic system and economic reforms. Count

Risk Insurance – Role of OPIC and MIGA; Nature of legal environment; International Protection.

International Political Environment

Political Environment : The influence of political environment on business is enormous. Politic

environment includes:

1) Political ideology of government regarding :

a. Foreign investment

 b.  Foreign trade

c.  Tariffs

d.  Working of MNCs

e.  Price Controls

f.  Liberalisation

g.  Globalisation

h. Privatisation etc.

(2) Political stability in the country.

Forms of Political System 

Democracy

o  Parliamentary Democracy

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o  Presidential Democracy

Totalitarian System

Secular Totalitarianism

Theocratic Totalitarianism

The political scenario often varies between the two extremes :

Democracy : The purest form of democracy represents direct involvement of citizens in policy makin

This is because, the democratic set-up is "of the people, for the people, and by the people". But with th

growing time and distance barriers over time, it did not remain feasible for all citizens to participate

the political process, and as a result, democracy turned into a representative democracy where only th

elected representative have a say in political decision. Whatever may be the form of democracy, th

 people enjoy fundamental rights of various kinds of freedom and civil liberties.

(i)  Parliamentary Democracy : In parliamentary democracy, political decisions a

influenced by widely varying interest groups.

(ii)  Presidential Democracy : On the contrary, they are comparatively centralized

 presidential democracy, although the head of the government is an elect

representative.

Totalitarianism : Totalitarianism, at the other extreme, represents monopolization of political power

the hands of an individual or a group of individuals with virtually no opposition. The policy is simp

the dictates of the ruler. Constitutional guarantee are denied by the citizens.

Types of Political Environment : Political environment is of three types:

(1) Political Environment of Domestic Country : It refers to political environment of the count

in which MNC operates. Usually less developed countries view foreign firms and

foreign capital investment with distrust. On the other hand, different political parties, especial

opposition parties often accuse foreign firms of not providing the latest technology, violating t

rules and seeking favours from the ruling party.

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(2)Political Environment of Foreign Country : It refers to political environment of the country

which MNC belongs. MNCs are also affected by political ideology of their parent country.

(3)International Political Environment : International political environment is created from th

interaction between the domestic and foreign political environment. International politic

environment is changing very fast and these changes affect the domestic, economic and politic

environment.

Political Risk : There is no precious definition. However, in Thunell's view, political risk is said

exist when sudden and unanticipated changes in political set-up in the host country lead to unexpecte

discontinuities that bring about changes in the very business environment and corporate performanc

For Example, if a rightist party wins election in the host country and the policy towards foreig

investment turns liberal, it would create a positive impact on the operation of MNCs. On the other han

if a left party comes to power in the host country, it will have a negative impact on the operation o

MNCs. It is the negative impact that is normally the focus of attention of transnational investors.

Forms of Political Risks : Some of the forms of political risks are:

Expropriation : Expropriation means seizure of private property by the government. Confiscation

similar to expropriation, but the difference between two is that while expropriation involves payment

compensation, confiscation does not involve such payments. International law provides protection

foreigner's property. It provides for compensation in case of unavoidable seizure. But the process

compensation is often lengthy and cumbersome. The firm usually requires going-concern value tied

the present value of lost future cash flows. On the other hand, government prefers depreciated historic

 book value, which is lower in the eyes of the firm.

Currency Inconvertibility : Sometimes the host government enacts law prohibiting foreign compani

from taking their money out of the country or from exchanging the host country currency for any oth

currency. This is a financial form of political risk.

Credit Risk : Refusal to honour a financial contract with a foreign company or to honour foreign de

comes under this form of political risk.

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Risk from Ethnic, Religious, or Civil Strife : Political risk arises on account of war and violence an

racial, ethnic, religious or civil strife within a country.

Conflict of Interest : The interest of MNCs is normally different from the interest of the ho

government. The former manifests in the maximization of corporate wealth, while the latter is evide

in the welfare of the economy, in general and of the citizens of a constituency, in particular. It is t

conflicting interest that gives rise to political risk.

Corruption : Corruption is endemic in many host countries, as a result of which MNCs have to fa

serious problems. Transparency International has surveyed 85 countries and has brought out th

Corruption Perception Index. Many countries rank high on this index.

Evaluation or Assessment of Political Risk : Assessment of political risk is an important step beforefirm moves abroad. It is because if such risks are very high, the firm would not like to operate in th

country. If the risk is moderate or low, the firm will operate in that country, but with a suitable politica

risk management strategy. But any such strategy cannot be formulated until one assesses the magnitud

of political risk. The ways of assessment may be either qualitative or quantitative.

Management of Political Risk : The political risk management strategy depends upon the type of ri

and the degree of risk the investment carries. It also depends upon the timing of the steps taken. F

example, the strategy will be different if it is adopted prior to investment from that adopted during th

life of the project. Again, it will be different if it is adopted after expropriation of assets. Th

management of political risk is divided into three sections:

(A) Management Prior to Investment : Investment will prove a viable venture if political risk

managed from the very beginning-even before the investment is made in foreign land. At this stag

there are five ways to manage it.

(1)Increased in Discount Rate : In the first method, the factor of political risk is included in the ve process of capital budgeting and the discount rate is increased. But the problem is that it penalizes th

flows in the earlier years of operation, whereas the risk is more pronounced in the later years.

(2)Reducing the Investment Flow : The risk can be reduced through reducing the investment flo

from the parent to the subsidiary and filling the gap through local borrowing in the host country. In th

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strategy, it is possible that the firm may not get the cheapest fund, but the risk will be reduced. The fir

will have to make a trade-off between higher financing cost and lower political risk.

(3)Agreement with the Host government : If the investing company undergoes an agreement wi

the host government over different issues prior to making any investment, the latter shall be bound b

that agreement.

(4)Planned Divestment : Planned divestment is yet another method of reducing work. If the compan

 plans an orderly shifting of ownership and control of business to the local shareholders and

implements the plan, the risk of expropriation will be minimal.

(5)Insurance of Risk : Political risk can also be reduced by the insurance of risk.The investing fir

can be insured against political risk. Insurance can be purchased from governmental agencies, privafinancial service, organizations or from private property-centred insurers.

(B) Risk Management during the Life Time of the Project : Management of risk during the pr

investment phase lessens the intensity of risk, but does not eliminate it. So the risk management proce

continues even when the project is in operation. There are four ways to handle the risk in this phase.

(1)Joint Venture and Concession Agreement : In a joint venture agreement, the participants are loc

shareholders who have political power to pressurize the government to take a decision in their favour

in favour of the enterprise. In case of concession agreements that are found mainly in miner

exploration, the government of the host country retains ownership of the property and grants lease

the producer. The government is interested in earning from the venture and so it does not cancel th

agreement.

(2)Political Support : Risk can also be managed with political support. International compani

sometimes act as a medium through which the host government fulfils its political needs. As long

 political support is provided bythe home country government, the assets of the investing company asafe.

(3)Structured Operating Environment : The third method is through a structured operatin

environment. Political risk can be reduced by creating a linkage of dependency between the operatio

of the firm in high risk country and the operation of other units of the same firm in other countries.

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the unit in a high risk country is dependent on its sister units in other countries for the supply

technology or raw material , the former is normally not nationalized so long dependency is maintained

(4)Anticipatory Planning : Anticipatory planning is also useful tool in risk management. It is a fa

that the investing company takes necessary precautions against the political risk prior to the investme

or after the investment. But it is of utmost significance that it should plan the measures to be taken qui

in advance.

(C) Risk Management following Nationalisation : Despite care taken by the international firms f

minimizing the impact of political risk, there are occasions when nationalization takes place. In su

cases, the investing company tries to minimize the effects of such a drastic measure. There are man

ways to do it.

(1)The investing company negotiates with the host government on various issues and shows

willingness to support the policy and programmes of the latter. Sometimes the investing compan

foregoes majority control in order to please the host government.

(2)Political and Economic Pressure : On failure of negotiation with the host government, th

investing company tries to put political and economic pressure.

(3)Arbitration : If nationalization is not reversed through negotiation and political-economic pressur

the firm goes for arbitration. It involves the help of a neutral third party who mediates and asks for th

 payment of compensation.

(4)Approach the Court of Law : When the arbitration fails, the only way out is to approach the cou

of law. The international law suggests that the company has, first of all, to seek justice in the ho

country itself. If it is not satisfied with the judgement of the court, the company can go to th

international court of justicefor fixation of adequate compensation.

Legal Environment

There are wide variations between countries n the policies and regulations regarding the conduct of th

 business. For example, certain trade practices or promotional methods/strategies allowed in som

countries may be regarded as unfair by the laws of some other countries. In many countries there is a l

of restriction n the use of the media. Radio and Television, in particular are under State monopoly

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under strict state control in a number of countries. The advent of cable TV however, is creatin

 problems for regulation.

In most countries, apart from those laws that control investment and related matters, there are a numb

of laws that regulate the conduct of the business. These laws cover such matters as standards of produ

 packaging, promotion, ethics, ecological factors etc.

Business policies and regulations have much to do with the political system and the characteristics

the political parties and politicians.

In many countries with a view to protecting consumer interests, regulations have become stronge

Regulations to protect the purity of the environment and preserve the ecological balance have assume

great importance in many countries.

Some governments specify certain standards for the products (including packaging) to be marketed

the country: some even prohibit the marketing of certain products. In most nations promotion

activities are subject to various types of controls. Several European countries restrain the use

children in commercial advertisement. In a number of countries, including India, the advertisement

alcoholic liquor is prohibited. Advertisements, including packaging of cigarettes must carry th

statutory warning that cigarette smoking is injurious to health. Similarly, baby foods must not b

 promoted as a substitute for breast feedings. In countries like Germany, product compariso

advertisements and the use of superlatives like best or excellent in advertisements is not allowed. In th

United States, the Federal Trade Commission is empowered to require a company to provide sufficie

evidence to substantiate the claim concerning the quality, performance or comparative prices of i

 products.

There area host of statutory controls on business in India. Although the controls have been substantial

 brought down as a result of the liberalization, a number of controls still prevail.

Many countries today have laws to regulate competition in the public interest. Elimination of unfa

competition and dilution of monopoly power are the important objectives of these regulations.

Certain changes in government policies such as the industrial policy, fiscal policy, tariff policy etc. ma

have profound impact on business. Some policy developments create opportunities as well as threats.

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other words, a development which brightens the prospects of some enterprises may pose a threat

some others. For example, the industrial policy liberalizations in India have opened up ne

opportunities and threats. They have provided a lot of opportunities to a large number of enterprises

diversify and to make product mix better. But they have also given rise to serious threat to man

existing products by way of increased competition; many seller’s markets have given way

 buyer’s markets. Even products which were seldom advertised have come to be promoted ve

heavily. This battle for the market has provided a splendid opportunity for the advertising industry.

The legal systems that exist in different countries across the world may be classified into thre

categories, viz, common law, civil law or code law, and theocratic law.

The basis for common law is tradition, past practices, and legal precedents set by the courts throug

interpretations of statutes, legal legislation, and past rulings.

Code law, on the other hand, is based on an all-inclusive system of written rules (codes) of law. Und

code law, the legal system is generally divided into three separate codes: commercial, civil, an

criminal. The civil law system, also called a codified legal system, is based on a detailed set of laws th

make up a code. Rules for conducting business transactions are a part of the code.

The theocratic law system is based on religious precepts. The best example of this system is Islam

law, which is found in Muslim countries. Islamic law, or Shair’a, is based in the following source

The Koran, the sacred text; the Sunnah or decisions and sayings of the Prophet Mohammad; th

writings of Islamic scholars, who derive rules by analogy from the principles established in the Kor

ad the Sunnah; and the consensus of Muslim countries’ legal communities. 

Human-Cultural Environment 

Human-Cultural Environment : Business is an integral part of society and both influence each othe

Human-Cultural Environment: Human cultural environment is studied into four parts:

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Meaning of Culture : Culture represents the entire set of social norms and responses that dominate th

 behavior of persons living in a particular geographic or political  boundary. It is a fact that cultur

 boundaries may differ from national/political  boundaries because individuals with varying cultur

 back-grounds may reside in a  particular nation.

Culture as noted earlier represents the whole set of social norms and responses that shape the

o  Knowledge

o  Beliefs

o  Morals

o  Attitude

o  Behavior and

o  The very way of life of a person or a group of persons.

Culture is not in-born. It is acquired and inculcated.

Elements of Culture : Based on the definition of culture, there are a few basic elements of cultur

These elements are universal, meaning that they from the cultural environment of all societies. Bu

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what is important is that they perform differently in different societies, leading ultimately to cultur

diversity across different societies. Czinkota et al list these elements as follows:

(1)Language : Language is the medium through which message is conveyed. It may be verbal or no

verbal. The former includes the use of particular words or how the words are pronounced. When a

international manager gives the instructions to his subordinates, who normally come from the ho

country, the instructions must be understood properly by the latter. There is no problem, if the languag

spoken in the home country and the host country is similar. But normally it is not.

(2)Religion : Religion is another element of culture. Irrespective of forms, religion believes in a high

 power. It sets the ideals of life and thereby the values and attitude of individuals living in a societ

These values manifests in individual's behavior and performance.

(3)Education : The level of education in a particular culture depends primarily on the literacy rate an

on enrolment in schools and colleges. This element has a close relationship with the availability

skilled manpower, availability of workers and managers who can be sent to the home country f

training, production of sophisticated products and with the adaptation of imported technology. If th

level of education is high in a particular society, it is easy for multinational firms to operate there. It

 because skilled manpower will be easily available, its training will be east and the firm will be able

 produce sophisticated goods.

(4)Attitude and Values : Values are belief and norms prevalent in a particular society. They determin

largely the attitude and behavior of individuals towards work, status, change and so on. In som

societies, where income and wealth are emphasized upon, people work for more hours ion order to ea

more. On the contrary, in societies where leisure is preferred, people work only for limited hours, just

meet their essential wants necessary for survival. Again the attitude towards social status is

important factor. Those who believe in higher social status spend even more and to this end they wo

more and earn more.

(5)Customs : Customs and manners vary from one society to another. In the United State of Americ

silence is taken as negation, while it is not so in Japan.

(6)Social Institutions : Social institutions form an integral part of culture. They are concerned main

with the size of the family and social stratification. In the United State of America and the Unite

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Kingdom and most other developed countries, the size of the family is small, comprising of a husban

wife and children. But in many other countries, especially in developing ones, grand parents too are

 part of the family. In yet another group of countries the family is larger comprising of cousins, aun

and uncles. In India, the joint family system is still prevalent.

Cultural Diversity : In the preceding section, it has been mentioned how the various elements

culture vary in different societies. In some societies, individualism motivates personal accomplishmen

while in others, the concept of the group is prominent. It is the cultural diversity that shapes th

managers as either risk averse or risk taking leaders. The former are conservative in their decision

while the latter are aggressive. Some managers give priority to long-term goals, while the others a

contended with achieving short-term goals. It is the cultural background that makes the two differe

from each other. But it is important to know that why such diversity exists. To explain the bases

diversity, a few of models have been developed.

(1)Hofstede's Study : Hofsede's study surveyed 117000 employees in 88 countries and suggests th

cultural diversity among nations has four dimensions. They are:

(i)Individualism/collectivism

(ii)Masculinity/ femininity

(iii)Power distance

(iv)Uncertainty avoidance

(2) Kluckhon and Strodtbeck's Study : Similarly, Kluckhon and Strodtbeck identify five problem

that tend to cultural diversity. They are:

(i)Human-Nature relationship

(ii)Orientation towards time

(iii)Beliefs about human nature

(iv)Activity orientation of human being

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(v)Inter-human relationship

(3) Fons Trompenaars' Study : Trompenaars' study covers 15,000 managers from 28 countries.

concludes that cultural diversity is found because of the existence of a few relationship orientatio

manifest in form of:

(i) Universalism vis-à-vis particularism

(ii) Neutralism vis-à-vis emotionalism, and

(iii)Achievement vis-à-vis ascription.

Diverse Culture and Competitive Advantage : If an MNC moves to a country with a similar cultur

envirornment, operational problems do not emerge on this count. But this is seldom a case. Generall

the culture in the parent company's country is found to be different from that in the country where i

subsidiaries exist. This causes serious operational problems and effects the competitive advantage

the firm, which lies at the very root of every MNC's success.

Cutural Diversity Impeding Competitive Advantage of an MNC : 

(i) Poor communication between top managers and subordinates

(ii)Non-responsive attitude leading to inefficiency

(iii)Lack of responsiveness towards innovated product/technology

(iv)Buying pattern among consumers may not encourage large scale production

(v)Varying concept of human resource management may weaken employer-employee relationship

(vi)Varying culture, limiting the scope for advertisement/sales promotion campaign

Management of Cultural Diversity : Lee outlines a procedure for decision making in differe

cultural setups. It is a four step model The successive steps are:

(i)To define the business goal from the home country perspective

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(ii)To define the same goal from host country perspective

(iii)To compare the two and note the differences, and

(iv)To eliminate the difference and to find an optimal solution

Role of OPIC and MIGA

OPIC

The Overseas Private Investment Corporation (OPIC) is the U.S. government‟s development finan

institution. It mobilizes private capital to help solve critical development challenges and, in doing s

advances U.S. foreign policy. Because OPIC works with the private sector, it helps U.S. businesses ga

footholds in emerging markets, catalyzing revenues, jobs and growth opportunities both at home an

abroad. OPIC achieves its mission by providing investors with financing, guarantees,  political ri

insurance, and support for private equity investment funds.

OPIC supports U.S. foreign policy objectives by encouraging development in regions that hav

experienced instability or conflict, yet offer promising growth opportunities, such as the Middle Ea

and  North Africa, sub‐Saharan Africa, and Southeast Asia. OPIC‟s work contributes to stability an

economic opportunity, which helps mitigate risk to U.S. companies investing abroad, and promotes

 positive developmental effect for the host countries.

OPIC operates on a self ‐sustaining basis at no net cost to American taxpayers. It generated net incom

of $269 million in Fiscal Year 2011,[1]  helping to reduce the federal budget deficit for th

34th consecutive year. To date, OPIC has supported nearly $200 billion of investment in more tha

4,000 projects, generated $75 billion in U.S. exports and supported more than 276,000 American jobs

Multilateral Investment Guarantee Agency (MIGA)

The Multilateral Investment Guarantee Agency (MIGA) is an international financial instituti

which offers political risk insurance guarantees. Such guarantees help investors protect foreign dire

investments against political and non-commercial risks in developing countries. MIGA is a member

the World Bank Group and is headquartered in Washington, D.C., United States. It was established

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1988 as an investment insurance facility to encourage confident investment in developing countrie

MIGA's stated mission is "to promote foreign direct investment into developing countries to suppo

economic growth, reduce poverty, and improve people's lives". The agency focuses on memb

countries of the International Development Association and countries affected by armed conflict.

targets projects that endeavor to create new jobs, develop infrastructure, generate new tax revenues, an

take advantage of natural resources through sustainable policies and programs.

MIGA is owned and governed by its member states, but has its own executive leadership and sta

which carry out its daily operations. Its shareholders are member governments which provide paid-

capital and have the right to vote on its matters. It insures long-term debt and equity investments as we

as other assets and contracts with long-term periods. The agency is assessed by an independe

evaluator each year. Its 2011 evaluation recommended that it utilize its recently expanded investin

capacity and closely monitor projects' profitability to better understand their impacts on its financi

 performance. MIGA's total investments amounted to $1.1 billion in 2011. It issued $2.1 billion worth

new investment guarantees in 2011 and held $1.5 million in total assets.

International Protection

WIPO-administered systems of international protection significantly simplify the process f

simultaneously seeking IP protection in a large number of countries. Rather than filing nation

applications in many languages, the systems of international protection enable you to file a sing

application, in one language, and to pay one application fee. These international filing systems not on

facilitate the process but also, in the case of marks and industrial designs, considerably reduce yo

costs for obtaining international protection (in the case of patents, the PCT helps your SME in gainin

time to assess the commercial value of your invention before national fees are to be paid in the nation

 phase). WIPO-administered systems of international protection include three different mechanisms

 protection for specific industrial property rights.

  International protection of inventions is provided under the PCT system, the worldwid

system for simplified multiple filing of patent applications. By filing one international pate

application under the PCT, you actually apply for protection of an invention in each of a larg

number of member countries (now more than one hundred) throughout the world.

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  International protection of trademarks is provided under the "Madrid system." The Madr

system simplifies greatly the procedures for registering a trademark in multiple countries th

are party to the Madrid system. An international registration under the Madrid system produc

the same effects as an application for registration of the mark filed in each of the countri

designated by the applicant and, unless rejected by the office of a designated country within

certain period, has the same effect in that country as a registration in the Trademark Registry

that country.

  International protection of industrial designs is provided by the Hague Agreement. Th

system gives the owner of an industrial design the possibility to have his design protected

several countries by simply filing one application with the International Bureau of WIPO, in o

language, with one set of fees in one currency.

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UNIT-III

Commodity Agreements, trading blocks, International trade, trade barriers  – tariff and non-tariff, tra

and international investments; types of foreign investments and factor affecting it.

Commodity Agreements

An international commodity agreement is an undertaking by a group of countries to stabilize trad

supplies, and prices of a commodity for the benefit of participating countries. An agreement usual

involves a consensus on quantities traded, prices, and stock management. A number of internation

commodity agreements serve solely as forums for  information exchange,  analysis, and  poli

discussion.

USTR leads United States participation in two commodity trade agreements: the International Tropic

Timber Agreement and the International Coffee Agreement (ICA). Both agreements establi

intergovernmental organizations with governing councils.

Trading Blocks

A trade bloc is a type of  intergovernmental agreement, often part of a regional intergovernment

organization, where regional barriers to trade, (tariffs and non-tariff barriers) are reduced or eliminat

among the participating states.[ 

Regional trade blocs are intergovernmental associations that manage and promote trade activities f

specific regions of the world.

Trade bloc activities have political as well as economic implications. For example, the European Unio

the world‟s largest trading block, has “harbored political ambitions extending far beyond the frtrading arrangements sought by other multistage regional economic organizations“ (Gibb and Michal

1994: 75). Indeed, the ideological foundations that gave birth to the EU were based on ensurin

development and maintaining international stability, i.e., the containment of communist expansion

 post World War II Europe (Hunt 1989). The Maastricht Treaty which gave birth to the EU in 199

included considerations for joint policies in regard to military defense and citizenship.

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The decisions reached by development policy makers on whether regionalism or globalized trad

should be pursued may influence a country‟s earnings from trade. 

Regionalism differs from globalization in the size and area of markets. From the perspective

developing countries skeptical of free trade, regional trade blocs offer some form of protection again

an aggressive global market.

Four major trade blocs:-

Some well known trading blocs include the EU (European Union; see Map 1), NAFTA (Nor

American Free Trade Agreement; see Map 2), MERCOSUR (Mercado Comun del Cono Sur, als

known as Southern Common Markets (SCCM); see Map 3), and ASEAN (Association of Southea

Asian Nations; see Map 4). The following maps show trade data for 2001 (UNCTAD 2002). The seriof pie charts display the export composition of trade from each country in the bloc.

Interregional Trade

Interregional trade is trade that takes place between two or more regions.

The exports and imports of a region. Measurement and meaning confound the use of the ter

interregional trade: first, the measure of gross exports, the out-shipments of goods and services

 producers and consumers outside a region; second, the measure of gross imports, the in-shipments

goods and services for the use of economic units inside the region. Apropos to both measures is t

concept of the region itself. In an economic sense, a region is a collection of local labor market areas

the commuting areas of central places that are the areas‟ trade centers. Further distinctions refer to rur

versus urban and metropolitan regions.

The trading region includes the infrastructure of commerce as well as the export-producing businesse

their workers and production facilities, and a host of residential activities catering to these business

and their workers and households. All are important participants in the initiation and support

interregional trade, the inevitable result of businesses and workers exercising their particul

competitive advantage through remunerative product specialization. We therefore address the topic b

defining and identifying interregional trade within and between trading regions and, finally, accountin

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for the variability and value of interregional trade arising from the product specialization of its expor

 producing businesses and industries.

Trade Barriers : Tariff and Non- Tariff 

International trade increases the number of goods that domestic consumers can choose from, decreas

the cost of those goods through increased competition, and allows domestic industries to ship the

 products abroad. While all of these seem beneficial, free trade isn't widely accepted as complete

 beneficial to all parties. This article will examine why this is the case, and look at how countries react

the variety of factors that attempt to influence trade. (To start with a discussion on trade, see What

 International Trade? and The Globalization Debate.)

What Is a Tariff?

In simplest terms, a tariff  is a tax. It adds to the cost of imported goods and is one of several tra

 policies that a country can enact.

Why Are Tariffs and Trade Barriers Used?

Tariffs are often created to protect infant industries and developing economies, but are also used b

more advanced economies with developed industries. Here are five of the top reasons tariffs are used:

1.  Protecting Domestic Employment  

The levying of tariffs is often highly politicized. The possibility of increased competition fro

imported goods can threaten domestic industries. These domestic companies may fire worke

or shift production abroad to cut costs, which means higher  unemployment and a less happ

electorate. The unemployment argument often shifts to domestic industries complaining abo

cheap foreign labor, and how poor working conditions and lack of regulation allow foreig

companies to produce goods more cheaply. In economics, however, countries will continue

 produce goods until they no longer have a comparative advantage (not to be confused with absolute advantage).

2.  Protecting Consumers  

A government may levy a tariff on products that it feels could endanger its population. F

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example, South Korea may place a tariff on imported beef from the United States if it thinks th

the goods could be tainted with disease.

3.  I nfant I ndustries  

The use of tariffs to protect infant industries can be seen by the Import Substitutio

Industrialization (ISI) strategy employed by many developing nations. The government of

developing economy will levy tariffs on imported goods in industries in which it wants to fost

growth. This increases the prices of imported goods and creates a domestic market f

domestically produced goods, while protecting those industries from being forced out by mo

competitive pricing. It decreases unemployment and allows developing countries to shift fro

agricultural products to finished goods.

Criticisms of this sort of  protectionist strategy revolve around the cost of  subsidizing t

development of infant industries. If an industry develops without competition, it could wind u

 producing lower quality goods, and the subsidies required to keep the state-backed indust

afloat could sap economic growth.

4.  National Securi ty 

Barriers are also employed by developed countries to protect certain industries that are deeme

strategically important, such as those supporting national security. Defense industries are ofteviewed as vital to state interests, and often enjoy significant levels of protection. For exampl

while both Western Europe and the United States are industrialized, both are very protective o

defense-oriented companies.

5.  Retaliation 

Countries may also set tariffs as a retaliation technique if they think that a trading partner h

not played by the rules. For example, if France believes that the United States has allowed i

wine producers to call its domestically produced sparkling wines "Champagne" (a name specif

to the Champagne region of France) for too long, it may levy a tariff on imported meat from th

United States. If the U.S. agrees to crack down on the improper labeling, France is likely to sto

its retaliation. Retaliation can also be employed if a trading partner goes against th

government's foreign policy objectives.

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Types of Tariffs and Trade Barriers

There are several types of tariffs and barriers that a government can employ:

 Specific tariffs

  Ad valorem tariffs

  Licenses

  Import quotas

  Voluntary export restraints

  Local content requirements

Specifi c Tari ff s  

A fixed fee levied on one unit of an imported good is referred to as a specific tariff. This tariff can var

according to the type of good imported. For example, a country could levy a $15 tariff on each pair

shoes imported, but levy a $300 tariff on each computer imported.

Ad Valorem Tarif fs  

The phrase ad valorem is Latin for "according to value", and this type of tariff is levied on a good bas

on a percentage of that good's value. An example of an ad valorem tariff would be a 15% tariff levi

 by Japan on U.S. automobiles. The 15% is a price increase on the value of the automobile, so a $10,00

vehicle now costs $11,500 to Japanese consumers. This price increase protects domestic producers fro

 being undercut, but also keeps prices artificially high for Japanese car shoppers.

Non-tariff barriers to trade include:

Licenses  

A license is granted to a business by the government, and allows the business to import a certain type

good into the country. For example, there could be a restriction on imported cheese, and licenses wou

 be granted to certain companies allowing them to act as importers. This creates a restriction o

competition, and increases prices faced by consumers.

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Import Quotas 

An import quota is a restriction placed on the amount of a particular good that can be imported. Th

sort of barrier is often associated with the issuance of licenses. For example, a country may place

quota on the volume of imported citrus fruit that is allowed.

Voluntary Export Restraints (VER) 

This type of trade barrier is "voluntary" in that it is created by the exporting country rather than th

importing one. A voluntary export restraint is usually levied at the behest of the importing country, an

could be accompanied by a reciprocal VER. For example, Brazil could place a VER on the exportatio

of sugar to Canada, based on a request by Canada. Canada could then place a VER on the exportatio

of coal to Brazil. This increases the price of both coal and sugar, but protects the domestic industries.

Local Content Requi rement  

Instead of placing a quota on the number of goods that can be imported, the government can requir

that a certain percentage of a good be made domestically. The restriction can be a percentage of th

good itself, or a percentage of the value of the good. For example, a restriction on the import

computers might say that 25% of the pieces used to make the computer are made domestically, or c

say that 15% of the value of the good must come from domestically produced components.

Trade and International Investment

The strategy of selecting globally-based investment instruments as part of an investment portfoli

International investing includes such investment vehicles as mutual funds, American Deposito

Receipts, exchange-traded funds (ETFs) or direct investments in foreign markets. People often inve

internationally for diversification, to spread the investment risk among foreign companies and market

and for growth, to take advantage of emerging markets.

Why International? 

Most investors tend to invest in what they know. This isn't necessarily a bad thing as it's important t

have a good understanding of your investments; however, it becomes detrimental when the blinders a

 put on and people refrain from learning about other investments. International investing, in particular,

a strategy sometimes overlooked by investors as a means of diversification.

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With all the volatility found in stock markets, it's difficult enough to pick winning stocks let alon

winning economies. This is where diversification through international investing can help. Every yea

the economic performance of a country will fluctuate and this undoubtedly affects the stock market. B

 buying securities in different markets as opposed to purchasing only U.S. stocks and bonds, you c

reduce the impact of country or region-specific economic problems. (For more information, see C

You "Learn" The Stock Market?) 

Take a look at the following chart:

Year 

Japan

Nikkei 

U.S. S&P

500 

Canada S&P TSX

Composite 

London FTSE

100 

1993 18.8% 9.7% 30% 24.3%

1994 -7.8% -2.3% -11.8% -14.3%

1995 11.6% 35.8% 23.7% 25.7%

1996 -11.9% 23.6% 23% 13.7%

1997 -12% 24.7% 9.7% 27.7%

1998 -12.8% 30.5% 0.4% 8%

1999 35% 9% 26% 6.3%

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2000 -29% -2% 9.9% 0.5%

2001 -27.8% -17.3% -17.9% -18%

2002 -16.6% -19.6% -11.5% -30.9%

2003 22.53% 22.38% 21.97% 11.66%

2004 6.13% 9.48% 11.70% 6.87%

2005 40.86% 3.84% 23.29% 15.92%

2006 4.87% 11.78% 12.23% 8.86%

2007 -10.44% 4.37% 10.10% 3.02%

2008 -40.51% -37.58% -37.31% -31.96%

2009 17.59% 19.67% 26.19% 17.87%

2010 -3.64% 11.00% 13.21% 8.12%

2011* -16.67% -2.82% -11.09% -9.27%

* As of December 2011

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This chart outlines the percentage returns on the indexes of international exchanges. With caref

inspection, we can see that the magnitude and direction of returns for these four indexes don't alway

coincide. There are years when one index is up while another is down, and other times when an ind

rises by nearly 36% while others rise only by 12%. By participating in these other markets, that i

through purchasing securities from other countries, an investor can, with the added benefit of high

returns in foreign exchanges, add some protection against a national downturn in the U.S. economy.

Different Types of International Investments 

There are numerous ways in which the ordinary investor can invest in foreign markets without havin

too much trouble. Here are a few of the major types offered by most brokerages.

American Depositary Receipts (ADRs)  

American depositary receipts are used by foreign countries unable to list on the  NYSE or  Nasda

which have domestic country regulations. ADRs mimic their domestic stocks very closely, and off

you a way of investing internationally without actually buying stock from a foreign exchange. On

ADR found on the NYSE is Nokia (NYSE:NOK). This company tracks its parent stock on the Helsin

Exchange almost identically, allowing investors the convenience of international diversification witho

actually leaving American exchanges.

Exchange-Traded Funds (ETFs)  

These investments offer a wide variety of international flavors. You can buy ETFs that track most

the major foreign indexes, and they allow investors to obtain a return based on a specific foreign mark

without having too great of an exposure. Also, because they trade and work like any other ETF, the

aren't expensive to trade and are relatively liquid. 

I nternational Funds  

International stock funds are comparable to international ETFs as they also provide for diversificati

 but have same drawbacks and benefits that are associated with regular funds and ETFs. One thing

remember is that in these international funds, a hired professional  portfolio manager  is in charge an

decides what to place in the portfolio. Be sure you do your research before buying such a fund to mak

sure that these investments and the trading strategy of the fund are in line with your preferences.

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Foreign Securi ties  

Many  brokerage firms will offer investors the ability to buy investments from different countri

directly from the brokerage's international trading desk. So, if you wanted to buy a stock in a compan

that doesn't trade on American markets, you can inquire with your brokerage to see if it will facilita

the trade for you through one of the brokerage's affiliated international companies that has

membership on the foreign exchange or market. Because these trades are typically more expensive an

less liquid than regular domestic trades, you should carefully check out all of the other alternativ

 before you decide to do it this way.

Eurobonds  

 Not recommended for the beginner investor, these are bonds issued in foreign markets by domest

companies. An example of this would be if Sony were to issue a bond that matures in yen for Americ

investors. Eurobonds don't always offer higher yields than domestic bonds, and they are only as secu

as the company issuing them, but they are a way you can participate in a foreign fixed-income mark

One of the main reasons that beginner investors should be wary of these bonds is that they pay a foreig

currency that the investor will probably have to exchange.

International investment or capital flows fall into four principal categories: commercial loans, offici

flows, foreign direct investment (FDI), and foreign portfolio investment (FPI).

Commercial loans, which primarily take the form of bank loans issued to foreign businesses

governments.

Official flows, which refer generally to the forms of development assistance that developed nations giv

to developing ones.

Foreign direct investment (FDI) pertains to international investment in which the investor obtains

lasting interest in an enterprise in another country. Most concretely, it may take the form of buying

constructing a factory in a foreign country or adding improvements to such a facility, in the form

 property, plants, or equipment.

FDI is calculated to include all kinds of capital contributions, such as the purchases of stocks, as well

the reinvestment of earnings by a wholly owned company incorporated abroad (subsidiary), and th

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lending of funds to a foreign subsidiary or branch. The reinvestment of earnings and transfer of asse

 between a parent company and its subsidiary often constitutes a significant part of FDI calculations.

According to the United Nations Conference on Trade and Development (UNCTAD), the glob

expansion of FDI is currently being driven by over 65,000 transnational corporations with more tha

850,000 foreign affiliates.

An investor‟s earnings on FDI take the form of profits such as dividends, retained earning

management fees and royalty payments. 

Foreign portfolio investment (FPI), on the otherhand is a category of investment instruments that more easily traded, may be less permanent, and do not represent a controlling stake in an enterpris

These include investments via equity instruments (stocks) or debt (bonds) of a foreign enterprise whic

does not necessarily represent a long-term interest.

Stocks:

  dividend payments

  holder owns a part of a company

   possible voting rights

  open-ended holding period

Bonds:

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  interest payments

  ownership of bond rights only

  no voting rights

  specific holding period

While FDI tends to be commonly undertaken by multinational corporations, FPI comes from m

diverse sources such as a small company‟s pension or through mutual funds held by individuals. 

The returns that an investor acquires on FPI usually take the form of interest payments or dividends.

Investments in FPI that are made for less than one year are distinguished as short-term portfolio flow

FPI flows tend to be more difficult to calculate definitively, because they comprise so many differen

instruments, and also because reporting is often poor. Estimates on FPI totals generally vary from leve

equaling half of FDI totals, to roughly one-third more than FDI totals.

The difference between FDI and FPI can sometimes be difficult to discern, given that they may overla

especially in regard to investment in stock. Ordinarily, the threshold for FDI is ownership of “

 percent or more of the ordinary shares or voting power” of a business entity (IMF Balance of Paymen

Manual, 1993).

Calculating Investment: Calculations of FDI and FPI are typically measured as either a “flow

referring to the amount of investment made in one year, or as “stock,” measuring the total accumulate

investment at the end of that year.

Until the 1980s, commercial loans from banks were the largest source of foreign investment

developing countries. However, since that time, the levels of lending through commercial loans hav

remained relatively constant, while the levels of global FDI and FPI have increased dramatically. Ov

the period 1991-1998, FDI and FPI comprised 90 percent of the total capital flows to developin

countries. Over the period of 1996-2006, FDI and FPI outflows from the United States more th

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doubled (International Monetary Fund, 2007). Global FDI flows decreased significantly from 200

2009 due to the Financial Crisis and finally started rising again in 2010.

Similarly, when viewed against the tremendous and growing volume of FDI and FPI, the fund

 provided in the past by governments through official development assistance, or lending by commerci

 banks the World Bank or IMF, are diminishing in importance with each passing year. Therefore, wh

one talks about the recent phenomenon of globalization, one is referring in large part to the effects

FDI and FPI, and these two instruments will therefore be the primary focus of this Issue in Depth.

Conclusion 

Aside from allocating assets amongst different securities and industries, international investing is

good alternative for diversification. It reduces the impact investors experience from the downturn of

specific economy and helps to increase returns on portfolios concentrated in domestic markets that a

no longer growing at a rapid rate. Furthermore, the availability for international products has increase

dramatically with the globalization of equity markets, so even the average investor can take advanta

of the benefits without paying too much. Before you decide upon diversifying internationally, be su

you research your investment closely so that you can make an informed decision.

Factors affecting Foreign Investment

Factors Affecting Foreign investment Decision 

(1) Stable, predictable macro economic policy.

(2) An effective and honest government.

(3) A large and growing market.

(4) Freedom of activity in the market.

(5) Minimal government regulation.

(6) Property rights at1d protection.

(7) Reliable 'infrastructure:(8) Availability of high-quality factors of production.

(9) A strong local currency.

(10) The ability to remit profits, dividends and interest.

(11) A fayourable tax climate.

(12) Freedom to operate between markets

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UNIT-IV

International finance environment; main exchange rate regimes; International monetary system anIMF; European monetary system and the „Euro‟; World bank (IBRD, IDA & IFC); Euro Markets an

their working.

International Finance Environment

An international financial environment represents the conditions for activity in the economy or in th

financial markets around the world. It can be influenced by something major, such as the cred

worthiness of one country's debt. Governments, corporations, and other investors around the wor participate in purchasing the debt of other nations as profit opportunities arise. A downgrade of

country's debt by a rating's agency could damage the value of that country's debt and suggest that

default might be imminent. These conditions have the potential to trigger a sell-off, which is when the

are more sellers than buyers of risky debt in the markets.

A brief definition of the global financial system (GFS) is: The financial system consisting

institutions, their customers, and financial regulators that act on a global level.

The WHO defines it as "...various official and legal arrangements that govern international financi

 flows in the form of loan investment, payments for goods and services, interest and profit remittance

The main elements are the surveillance and monitoring of economic and financial stability, an

 provision of multilateral finance to countries with balance of payments difficulties. The organization

the centre of the system is the International Monetary Fund (IMF), which has the mandate to ensure i

effective running.".

The Financial Times lexicon defines it as:"..interplay of financial companies, regulators an

institutions operating on a supranational level. The global financial system can be divided in

regulated entities (international banks and insurance companies), regulators, supervisors an

institutions like the European Central Bank or the International Monetary Fund.The system al

includes the lightly regulated or non-regulated bodies - this is known as the “shadow banking” system

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 Mainly, this covers hedge funds, private equity and bank sponsored entities such as off-balance-she

vehicles that banks use to invest in the financial markets." [2]. 

The term global is often used synonymously with the terms "international" or "multinational

Economists do not have a standard definition for a global versus a multinational company. [3]. 

Main Exchange Rate Regims

An exchange-rate regime is the way an authority manages its currency in relation to other currenci

and the foreign exchange market. It is closely related to monetary policy and the two are general

dependent on many of the same factors.

The basic types are a floating exchange rate, where the market dictates movements in the exchange rat

a pegged float , where a central bank keeps the rate from deviating too far from a target band or valu

and a  fixed  exchange rate, which ties the currency to another currency, mostly more widespre

currencies such as the U.S. dollar or the euro or a basket of currencies.

Types

Float

Floating rates are the most common exchange rate regime today. For example, the dollar, euro, yen, anBritish pound all are floating currencies. However, since central banks frequently intervene to avo

excessive appreciation or depreciation, these regimes are often called managed float  or a dirty float . 

Pegged float

Pegged floating currencies are pegged to some band or value, either fixed or periodically adjuste

Pegged floats are:

Crawling bands

The rate is allowed to fluctuate in a band around a central value, which is adjusted periodically. This

done at a preannounced rate or in a controlled way following economic indicators. 

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Fixed

Fixed rates are those that have direct convertibility towards another currency. In case of a separa

currency, also known as a currency board arrangement, the domestic currency is backed one to one b

foreign reserves. A pegged currency with very small bands (< 1%) and countries that have adopte

another country's currency and abandoned its own also fall under this category.

Dollarization

Dollarization occurs when the inhabitants of a country use foreign currency in parallel to or instead

the domestic currency. The term is not only applied to usage of the United States dollar, but general

to the use of any foreign currency as the national currency. Zimbabwe is a good example

dollarization since the collapse of the Zimbabwean dollar.

International Monetary System

International monetary systems are sets of internationally agreed rules, conventions and supportin

institutions, that facilitate international trade, cross border investment and generally the reallocation

capital between nation states. They provide means of payment acceptable between buyers and sellers

different nationality, including deferred payment. To operate successfully, they need to inspi

confidence, to provide sufficient liquidity for fluctuating levels of trade and to provide means by whicglobal imbalances can be corrected. The systems can grow organically as the collective result

numerous individual agreements between international economic factors spread over several decade

Alternatively, they can arise from a single architectural vision as happened at Bretton Woods in 1944.

IMF

The International Monetary Fund (IMF) is an organization of 188 countries, working to foster glob

monetary cooperation, secure financial stability, facilitate international trade, promote high employme

and sustainable economic growth, and reduce poverty around the world.

The International Monetary Fund (IMF) is an international organization that was initiated in 1944

the Bretton Woods Conference and formally created in 1945 by 29 member countries. The IMF's state

goal was to stabilize exchange rates and assist the reconstruction of the world‟s   international payme

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system post-World War II. Countries contribute money to a pool through a quota system from whic

countries with payment imbalances can borrow funds temporarily. Through this activity and others su

as surveillance of its members' economies and policies, the IMF works to improve the economies of i

member countries.[1] The IMF describes itself as “an organization of 188 countries, working to fost

global monetary cooperation, secure financial stability, facilitate international trade, promote hig

employment and sustainable economic growth, and reduce poverty around the world.”[2]  T

organization's stated objectives are to promote international economic cooperation, international trad

employment, and exchange rate stability, including by making financial resources available to memb

countries to meet balance of payments needs.[3] Its headquarters are in Washington, D.C., United State

Functions

The IMF works to foster global growth and economic stability. It provides policy advice and financin

to members in economic difficulties and also works with developing nations to help them achie

macroeconomic stability and reduce poverty.[42]  The rationale for this is that private internation

capital markets function imperfectly and many countries have limited access to financial markets. Su

market imperfections, together with balance of payments financing, provide the justification for offici

financing, without which many countries could only correct large external payment imbalances throug

measures with adverse effects on both national and international economic prosperity.[43] The IMF c

 provide other sources of financing to countries in need that would not be available in the absence of economic stabilization program supported by the Fund.

Upon initial IMF formation, its two primary functions were: to oversee the fixed exchange ra

arrangements between countries,[44] thus helping national governments manage their exchange rates an

allowing these governments to prioritize economic growth,[45] and to provide short-term capital to a

 balance-of-payments.[44]  This assistance was meant to prevent the spread of international econom

crises. The Fund was also intended to help mend the pieces of the international economy post the Gre

Depression and World War II.[46] 

The IMF‟s role was fundamentally altered after the floating exchange rates  post 1971. It shifted

examining the economic policies of countries with IMF loan agreements to determine if a shortage

capital was due to economic fluctuations or economic policy. The IMF also researched what types

government policy would ensure economic recovery.[47]  The new challenge is to promote an

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implement policy that reduces the frequency of crises among the emerging market countries, especial

the middle-income countries that are open to massive capital outflows.[48] Rather than maintaining

 position of oversight of only exchange rates, their function became one of “surveillance” of the overa

macroeconomic performance of its member countries. Their role became a lot more active because th

IMF now manages economic policy instead of just exchange rates.

In addition, the IMF negotiates conditions on lending and loans under their policy of conditionality,[

which was established in the 1950s.[46] Low-income countries can borrow on concessional terms, whi

means there is a period of time with no interest rates, through the Extended Credit Facility (ECF), th

Standby Credit Facility (SCF) and the Rapid Credit Facility (RCF). Nonconcessional loans, whi

include interest rates, are provided mainly through Stand-By Arrangements (SBA), the Flexible Cred

Line (FCL), the Precautionary and Liquidity Line (PLL), and the Extended Fund Facility. The IM

 provides emergency assistance via the newly introduced Rapid Financing Instrument (RFI) to all

members facing urgent balance of payments needs.[49] 

European Monetary System and Euro

The European Monetary System (EMS) was the forerunner of Economic and Monetary Union (EMU

which led to the establishment of the Euro. It was a way of creating an area of currency stabilit

throughout the European Community by encouraging countries to co-ordinate their monetary policie

It used an Exchange Rate Mechanism (ERM) to create stable exchange rates in order to improve tra

 between EU member states and thus help the development of the single market. Stable money had be

a key part of international economic calculations since World War II. However, by the 1980s, opinio

about it was much more divided. As a result, not all countries took part in the EMS straight away, an

there were deeper splits in the years to come over the role of the EU in setting monetary policy as th

EMS was replaced with the Euro.

History

The EMS was launched in 1979 to help lead to the ultimate goal of EMU that had been set out in th

Werner Report (1970). Since World War II, attempts had been made to maintain currency stabili

amongst major currencies through a system of f ixed exchange rates called the Bretton Woods System

This collapsed in the early 1970s. However, European leaders were keen to maintain the principle

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stable exchange rates rather than moving to the policy of  fl oating exchange rates that was gainin

 popularity in the USA. This led them to create the EMS. It was not an entirely successful mov

 because, firstly, it posed many technical difficulties in setting the correct rate for all member states, an

secondly, some members were less committed to it than others. Britain didn't join the ERM until 199

and was forced to leave it in 1992 because it could not keep within the exchange rate limits. Th

 project, however, continued: under the Maastricht Treaty (1992), the EMS became part of the wid

 project for EMU that was developed during the 1990s. When the Euro came into being in 1999, t

EMS was effectively wound up, although the ERM remained in operation.

How did the European Monetary System work?

The most important part of the EMS was the Exchange Rate Mechanism. This committed all memb

states' governments to keep their currency exchange rates within bands. This meant that no country

exchange rate could fluctuate more than 2.25% from a central point. This was designed to help crea

stable commerce without the fear that sudden changes in the values of currencies would dampen tra

and encourage the development of trading barriers between member states.

It also created a European Currency Unit (ECU) to be used as a uni t of account . Although not a re

currency, the ECU became the basis for the idea of creating a single currency - an idea that was realis

with the launch of the Euro in 1999.

World Bank 

The World Bank is an international financial institution that provides loans[3] to developing countri

for capital programs. 

The World Bank's official goal is the reduction of poverty. According to the World Bank's Articles

Agreement (as amended effective 16 February 1989), all of its decisions must be guided by

commitment to promote foreign investment, international trade, and facilitate capital investment.

[4]

 

The World Bank differs from the World Bank Group, in that the World Bank comprises only tw

institutions: the International Bank for Reconstruction and Development (IBRD) and the Internation

Development Association (IDA), whereas the latter incorporates these two in addition to three more:

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International Finance Corporation (IFC), Multilateral Investment Guarantee Agency (MIGA), an

International Centre for Settlement of Investment Disputes (ICSID).

International Bank for Reconstruction and Development

The International Bank for Reconstruction and Development (IBRD) aims to reduce poverty in middl

income countries and creditworthy poorer countries by promoting sustainable development throug

loans, guarantees, risk management products, and analytical and advisory services. Established in 194

as the original institution of the World Bank Group, IBRD is structured like a cooperative that is own

and operated for the benefit of its 188 member countries. 

IBRD raises most of its funds on the world's financial markets and has become one of the mo

established borrowers since issuing its first bond in 1947. The income that IBRD has generated over th

years has allowed it to fund development activities and to ensure its financial strength, which enables

to borrow at low cost and offer clients good borrowing terms.

The oldest of the World Bank agencies - the International Bank for Reconstruction and Developme(IBRD) - was set up in 1944 at a conference convened in the town of Bretton Woods, New Hampshir

at the end of the Second World War with the original intention of providing low interest loans

Europe and Japan to help rebuild their infrastructure after the devastation of the war. This plan w

scuppered when these countries opted instead to take money from the United States Marshall Pla

which provided grants (money that does not have to be repaid), for the same purpose. Over the ne

few decades the IBRD rewrote its original mandate to provide cheap loans to the Third World instead

The two men who shaped the institution were probably John Maynard Keynes, the brains behind th

Bretton Woods conference (also the architect of the Gross National Product economic indicator) an

Robert McNamara, who headed up the World Bank in the 1970s, after he left his job at the Pentago

spearheading the Vietnam War for the United States. Today the IBRD's policies are dictated by th

member countries who run the institution. Although almost every country in the world is a member, th

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agency is ruled on the principal "one dollar, one vote" and so it is controlled by the US, the UK, Japan

Germany, France, Canada, and Italy -- the "Group of 7," which holds over 40% of the votes on the

 boards

In fiscal 1999, the IBRD loaned out US$22.2 billion, up from US$21 billion dollars the previous yea

making it the biggest source of development capital for Third World countries and the former Sovi

 bloc. Many of these loans are for major industrial development projects like dam building, power plan

and mining for non-renewable resources like gold and copper. In addition the IBRD dispenses loans f

social matters such as education and health but these loans are often linked to strict economic polici

such as Structural Adjustment Programs that have often exacerbated local problems. Finally becau

these loans are often designed in Washington by the Bank's own staff, they often reflect theoretic

models that have little relevance in the borrowing countries.

A leaked May 1999 draft Bank review of structural and sectoral adjustment loans severely criticiz

their treatment of environmental and social issues. The review assessed 54 such loans approve

 between July 1997 and December 1998 and found that only 20% contained a environmental goals

conditionalities - down from 60% in 1994. Furthermore, according to the document, '' the majority

loans do not address poverty directly, the likely economic impact of proposed operations on the poo

or ways to mitigate negative effects of reform.''

Although most projects did achieve their short-term physical objectives, according to the report, on

44% were likely to be sustained after completion - largely because staff appraisals underestimated th

 projects' recurrent costs, which would have to be borne by the agency's borrowers.

The IBRD makes loans to countries at the best possible market rates because its bonds have the highe

 possible credit rating on Wall Street. The agency has this high rating because almost all its borrowe

 pay their loans back on time, although the way many borrowers do this is by taking out fresh loans.

fact the Bank often receives more money in debt repayments than it makes in loans. Contrary to publ

opinion, the agency is not even a non-profit organization: the Bank routinely makes a billion dollars

 profits every year on the loans it makes.

IBRD has three major sister agencies - the International Development Agency (IDA), the Internation

Finance Corporation (IFC) and the Multilateral Investment Guarantee Agency. These four and th

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much smaller International Center for the Settlement of Investment Disputes (ICSID) make up th

World Bank group. Unlike the IBRD the IDA makes loans at almost no interest over much long

 periods of time (a 0.5% handling fee is charged) to the poorest countries. This agency loaned o

US$6.8 billion dollars in fiscal 1999, down from the US$7.5 billion dollars that it loaned out in 1998.

The IFC and MIGA do not make loans to countries. Instead the IFC makes loans to priva

corporations that have projects in the Third World and former Soviet bloc. This includes maj

multinational corporations like Shell and Coca-Cola. MIGA provides political risk insurance

companies that are worried that their assets may be seized by local governments or destroyed in war

other civil disturbances.

The region that received the most loans from IBRD and IDA was East Asia and the Pacific, strugglin

to recover from the financial crisis of 1997-98, with US$9.8 billion, followed by Latin America and th

Caribbean with US$7.7 billion. The region suffered ripple effects from the East Asian meltdown

well as the ravages of Hurricane Mitch, which struck Central America in October, 1998. Europe an

Central Asia came third, with US$5.3 billion in new commitments, followed by South Asia US$2

 billion, sub- Saharan Africa with US$2.1 billion and the Middle East and North Africa with US$1

 billion.

Argentina is the Bank's largest borrower with US$3.2 billion in commitments from the Bank in fisc

1999, followed by Indonesia, with US$2.7 billion in commitments, China with US$2.1 billion, Sou

Korea with US$2 billion, Russia with US$1.9 billion, Brazil with US$1.7 billion, Thailand wi

US$1.3 billion, India with US$1.1 billion, Bangladesh US$1 billion, and Mexico with US$950 million

Financing designed to support over-arching policy themes such as privatization of state enterprises an

commercialization of services dominated the new commitments, with loans for 'multi- sector' projec

and policy reforms amounting to US$10.3. Some US$4.5 billion went to transportation, industrial, o

and gas, energy and mining projects, with another US$2.8 billion for agriculture, US$753 million f

water and sanitation and US$647 million dollars for urban development. Population, health an

nutrition projects accounted for another US$1.1 billion dollars. Education garnered US$1.3 billion an

US$2.7 billion were earmarked for social programs. Environmental lending amounted to US$54

million.

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IFC

The International Finance Corporation (IFC) is an international financial institution which offe

investment, advisory, and asset management services to encourage  private sector development

developing countries. The IFC is a member of the World Bank Group and is headquartered

Washington, D.C.,  United States. It was established in 1956 as the private sector arm of the Wor

Bank Group to advance economic development  by investing in strictly for-profit and commerci

 projects which reduce poverty and promote development. The IFC's stated aim is to create opportuniti

for people to escape poverty and achieve better living standards by mobilizing financial resources f

 private enterprise, promoting accessible and competitive markets, supporting businesses and oth

 private sector entities, and creating jobs and delivering necessary services to those who are povert

stricken or otherwise vulnerable. Since 2009, the IFC has focused on a set of development goals whic

its projects are expected to target. Its goals are to increase sustainable agriculture opportunitieimprove health and education, increase access to financing for  microfinance and business clien

advance infrastructure, help small businesses grow revenues, and invest in climate health.

The IFC is owned and governed by its member countries, but has its own executive leadership and sta

which conduct its normal business operations. It is a corporation whose shareholders are memb

governments which provide paid-in capital and which have the right to vote on its matters. Original

more financially integrated with the World Bank Group, the IFC was established separately an

eventually became authorized to operate as a financially autonomous entity and make independe

investment decisions. It offers an array of debt and equity financing services and helps companies fa

their risk exposures, while refraining from participating in a management capacity. The corporation al

offers advice to companies on making decisions, evaluating their impact on the environment an

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society, and being responsible. It advises governments on building infrastructure and partnerships

further support private sector development.

The corporation is assessed by an independent evaluator each year. In 2011, its evaluation repo

recognized that its investments performed well and reduced poverty, but recommended that th

corporation define poverty and expected outcomes more explicitly to better-understand its effectivene

and approach poverty reduction more strategically. The corporation's total investments in 201

amounted to $18.66 billion. It committed $820 million to advisory services for 642 projects in 201

and held $24.5 billion worth of liquid assets. The IFC is in good financial standing and received th

highest ratings from two independent credit rating agencies in 2010 and 2011.

Euro Markets and their working

Euromarkets

These can broadly be classified as Eurocurrency and Eurobond markets. We want to focus on ho

MNCs can use these international markets to meet their financing requirements.

Euromarkets (occasionally called „xenomarkets‟) are markets on which banks deal in a currency oth

than their own. For example, eurodollars are dollars held by banks outside the United States. The pref

„euro‟ refers to the fact that such deposits first appeared in Europe in around 1955. The origins of theurodollar are traceable partly to the Cold War, when the USSR (in particular) desperately neede

international liquidity  – dollars - but did not want to hold them in the United States. The rise of t

dollar as an international currency encouraged companies world-wide to hold dollar cash reserves, an

 banks to ask for dollars on deposit. Some countries decided that such deposits did not need to be

closely regulated as deposits in the national currency because they did not affect the internal mone

supply. This produced a very liberal loan market, particularly in comparison with the prevailing heav

 post-war regulation. On top of that, America‟s Q regulation (put in place by the 1933 Glass Steaga

Act) set a ceiling on the interest rates payable on bank deposits and so savers looked for more attracti

rates elsewhere. Similarly, eurobonds benefited from an equalisation tax imposed in 1963 on intere

 payable on foreign issues placed in the USA.

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London played a key role in the development of euromarkets. Eurodollar loans, still negligible in 195

rose to 25 billion dollars in 1968 and 130 billion in 1973. At that time London accounted for almo

80% of the market, which was still largely controlled by London branches of foreign banks  – most

American, but also some French, Japanese and German. By 1975 there were 243 such subsidiaries

London.

While the main incentive for the development of euromarkets was the avoidance of nation

regulations, their development also helped to weaken those same regulations by providing bo

 borrowers and lenders with alternatives to nationally regulated solutions. The logical outcome

euromarkets was the liberalisation of capital movements. They undoubtedly represented one nail in th

coffin of the Bretton Woods fixed exchange rate scheme, which assumed that central banks we

capable of controlling exchange rates; this they could only do if they could control capital flows,

least in the short term.

At present, the term „euromarket‟ is less often employed, since lending in a currency other than that

the borrower or lender has now become commonplace.

Eurocurrency market

Definition and background

The Eurocurrency market consists of banks (called Eurobanks) that accept deposits and make loans

foreign currencies. A Eurocurrency is a freely convertible currency deposited in a bank located in

country which is not the native country of the currency. The deposit can be placed in a foreign bank

in the foreign branch of a domestic US bank.

In the Eurocurrency market, investors hold short-term claims on commercial banks which intermedia

to transform these deposits into long-term claims on final borrowers.

The Eurocurrency market is dominated by US $ or the Eurodollar. Occasionally, during weak doll

 periods (latter part of 1970s and 1980s), the EuroSwiss franc and the EuroDM markets increased

importance. The Eurodollar market originated post WWII in France and England thanks to the fear

Soviet Bloc countries that dollar deposits held in the US may be attached by US citizens with claim

against communist governments!

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Thriving on government regulation

By using Euromarkets, banks and financiers are able to circumvent / avoid certain regulatory costs an

restrictions. Some examples are:

a)  Reserve requirements

 b)  Requirement to pay FDIC fees

c)  Rules or regulations that restrict competition among banks

Continuing government regulations and taxes provide opportunities to engage in Eurocurren

transactions. However, ongoing erosion of domestic regulations have rendered the cost and retu

differentials much less significant than before. As a result, the domestic money market an

Eurocurrency markets are closely integrated for most major currencies, effectively creating a sing

worldwide money market for each participating currency.

Illustration I

German firm sells medical equipment to institutional buyer in the US. It receives a US$ check draw

on Citicorp, NY. Initially this check is deposited in a checking account for dollar working capital us

But to earn a higher return (or rate of interest) on the $ 1 million the German firm decides to place th

funds in a time deposit with a bank in London, UK.

One million Eurodollars have thus been created by substituting a dollar account in a London bank f

the dollar account held in NY. Notice that no US $ left NY but ownership of the US deposit has mov

from a foreign corporation to a foreign bank. The London bank would not like to leave the funds idle

 NY account. If a government or commercial borrower is unavailable, the London bank will place the

1 million in the London interbank market. The interest rate at which such interbank loans are made

called the London interbank offer rate (LIBOR).

This example demonstrates that the Eurocurrency market is a chain of deposits and a chain

 borrowers and lenders. The majority of Eurocurrency transactions involve transferring control

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deposits from one Eurobank to another Eurobank. Loans to non-Eurobank borrowers account for le

than half of all Eurocurrency loans.

The Eurocurrency market operates like any other financial market, but for the absence of governme

regulations on loans that can be made and interest rates that can be charged.

Eurocurrency loans

Eurocurrency loans are made on a floating – rate basis.

Interest rates on loans to governments, corporations and nonprime banks are set at a fixed margin abov

LIBOR for a given period and currency.

Example

If the margin is 75 basis points (b.p.) and the current LIBOR is 6%, the borrower is charged 6.75% f

the relevant period. LIBOR is the underlying variable rate of interest, usually set for a 6 month period

The margin or spread between the lending bank‟s cost of funds and the interest charged by the borrow

is based on the borrower‟s perceived creditworthiness / riskiness. The spreads can range from 15 b

to more than 300 b.p., the median of the range varying from 100 to 200 b.p.

The maturity of the Eurocurrency loan can range from 3 to 10 years. Eurocurrency loans are made b

 bank syndicates. The bank originating the loan becomes the lead bank managing the syndicate, invitin

one or two other banks to be co-managers of the loan. The borrower is charged a one-time syndicati

fee ranging from 0.25 % to 2 % of the loan value according to the size and type of the Eurocurrenc

loan.

The drawdown [period over which the borrower may use the loan] of the loan and the repayment perio

vary in accordance with the borrower‟s needs. A commitment fee of about 0.5 % per annum is paid o

the unused balance, and prepayments in advance of the agreed upon schedule are permitted but a

sometimes subject to a penalty fee.

i) EAC of Eurocurrency loan

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A corporate borrower has arranged a DM 500 million, five-year EuroDM loan with a bank syndica

led by two managing banks. The upfront syndication fee is 2 %.

 Net proceeds to the borrower = $ 500 mn – 0.02 (US $ 500 mn) = DM 490 mn.

The interest rate on the EuroDM loan is LIBOR + 1.75 %, with LIBOR reset every 6 months. If t

initial LIBOR6 rate for DM is 6 %, the first semiannual debt service payment is:

[(0.06 + 0.0175) / 2] * DM 500 mn = DM 19.3750 mn

Therefore the borrower‟s effective annual rate (EAC) for the first six months is:

[DM 19.3750 mn / DM 490 mn] * 2 * 100 = 7.9082 %

This EAC changes in every reset period (in this case 6 months) with LIBOR6.

ii) Multicurrency loans

Though most Eurocurrency loans are Eurodollar loans, these often come with a multicurrency claus

This clause gives the borrower the right (subject to availability) to switch from one currency to anoth

on any rollover (or reset) date. This option allows the borrower to match currencies with cash inflow

and outflows (which is an effective way of managing exposure to currency risk, and thus an effectiv

risk-management technique). The option also allows borrowers to take advantage of its ow

expectations regarding currency changes and search for funds with the lowest effective cost.

iii) Interest rates

Interest rates in national and Eurocurrency markets are closely linked through arbitrage.

US $ credit markets Sterling credit markets

US lending rate UK lending rate

Eurodollar lending rate Eurosterling lending rate

Eurodollar deposit rate Eurosterling deposit rate

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US deposit rate UK deposit rate

The difference between the Euro$ deposit rate and the Eurosterling deposit rate is given by the forwa

discount or premium (which approximates the expected change in the dollar/pound exchange rate).

Eurobond markets

Eurobonds are bonds sold outside the country whose currency they are dominated in. They are simil

in many ways to public debt sold in domestic capital markets. However, the Eurobond market

entirely free of official regulation and is self-regulated by the Association of International Bon

Dealers.

Borrowers in the Eurobond market are typically well known and have impeccable credit ratings (f

example, developed countries, international institutions, and large MNCs). The Eurobond market h

grown rapidly in the last two decades, and it exceeds the Eurocurrency market in size.

i)Currency denomination

About 75 % of Eurobonds are dollar denominated. The most important nondollar currencies f

Eurobond issues are DM and FF (now rapidly replaced by the euro), the JY and the BP [The Swicentral bank ban has led to the absence of SF Eurobonds].

ii)Fixed – rate Eurobonds

Fixed-rate Eurobonds pay coupons once a year, unlike the semiannual coupon, domestic bonds in t

US market. Borrowers compare the all-in cost, that is, the effective interest rate, on Eurobonds a

domestic bonds.

This interest rate is calculated as the discount rate that equates the present value of the future intere

and principal payments to the net proceeds received by the issuer, or as the IRR of the bond.

iii) Comparing Eurobond issue with a US domestic issue

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To compare a Eurobond issue with a US domestic issue, therefore, the all-in cost of funds on an annu

 basis must be converted to a semiannual basis or vice versa. Thus,

Semiannual yield = [1 + Annual yield]^0.5 – 1, and (1)

Annual yield = [1 + Semiannual yield]^2 – 1. (2)

Illustration II

P & G plans to issue a 5-year bond with a face value of $ 100 million. Its investment banker estimat

that a Eurobond issue would have to bear a 7.5 % coupon and that fees and other expenses will total

738,000 providing net proceeds to P & G of $ 99,262,000.

Exhibit 1 shows the cashflows associated with the Eurobond issue. The all-in cost (IRR) of this issu

which is an annual rate, is shown as 7.68 %. As a cross – check, the third column shows that the PV

the cashflows, using a discount rate of 7.68 %, sum to P & G „s net proceeds of $ 99,262,000. 

Alternatively, P & G can issue a $ 100 million, 5-year bond in the US market with a coupon of 7.4 %

With estimated issuance costs of $ 974,000, P & G will receive net proceeds of $ 99,026,000.

Exhibit 2 shows the cashflows associated with this issue and its all-in cost (IRR) of 3.82 %. Note th

the cashflows are semiannual, as is the all-in cost. Again, the third column does a cross-check confirm the 3.82 % all-in cost.

According to Equation (1) above, the equivalent semiannual all-in cost for the Eurobond issue

(1.0768)^0.5 – 1 = 3.77 %. Thus, the all-in cost of the Eurobond is lower, making it preferable if a

other terms and conditions on the two bonds are the same.

Alternatively, using Equation (2) above, we can convert the US bond yield to its annual equivalent an

compare that figure to the Eurobond yield of 7.68 %. This computation would have yielded

annualized all-in cost of the US bond issue equal to (1.0382)^2  – 1 = 7.78 %. As before, the Eurob

issue is preferable because its all-in cost is 10 basis points lower.