SOLUTION TO ASSIGNMENT

Question 1. Why is Comparative Cost Theory considered as an improvement upon Absolute Cost Advantage Theory? Explain Porter’s Diamond Model.

Answer.1. Comparative Cost Theory V/s Absolute Cost Advantage Theory 'Absolute Advantage' means the ability of a country, individual, company or region to produce a good or service at a lower cost per unit than the cost at which any other entity produces that good or service. The main concept of absolute advantage is generally attributed to Adam Smith for his most notable book ’Wealth of Nations‘ in 1776, Adam Smith attacked the mercantilism and argued that countries differ in their ability to produce goods and services efficiently due to variety of. A country that has an absolute advantage produces greater output of a good or service than other countries using the same amount of resources. Smith stated that tariffs and quotas should not restrict international trade; it should be allowed to flow according to market forces. Adam Smith’s theory suggests that such a country that has absolute advantage might not have benefitted from international trade as trade is positive sum game and countries prosper only if they exchange the goods in which they have absolute advantage. The answer to this problem can be found in the extension of absolute advantage, the theory of comparative advantage. David Ricardo, in his notable book ‘Principles of Political Economy’ published in 1817 came up with an improvement on Adam Smith’s ‘absolute advantage theory’ ie Comparative Cost theory. Comparative advantage refers to a country’s ability to produce a particular good with a lower opportunity cost than another country. Ricardo argued what might happen if one country has an absolute advantage in the production of all goods. For a sustainable economic system, Ricardo argued that a country should specialize in the production of those goods that it can produce most efficiently and import the goods which it produces less efficiently even if it has absolute cost advantage in the production of those goods.

2. Porter’s Diamond Model . A model that attempts to explain the competitive advantage some nations or groups have due to certain factors available to them. The Porter Diamond is a model that helps analyze and improve a nation's role in a globally competitive field. The model was developed by Michael Porter, who is recognized as an authority on company strategy and competition; it is a more proactive version of economic theories that quantify comparative advantages for countries or regions. Michael Porter considers the competitiveness of a country as a function of four major determinants:-

(a) Factor Conditions . Factor conditions being the inputs which affect competition in any industry comprise a number of broad categories. These could be Basic factors such as Natural resources: the abundance, quality, accessibility, and cost of the nation’s land, water, mineral, or timber deposits, hydroelectric power sources, fishing grounds, and other physical traits, Climate, Geographical location, and demographics or advanced factors like Human resources: the quantity, skills, and cost of personnel including management, Knowledge resources: the accumulated scientific, technical, research and market knowledge in a nation in the sphere of goods and services, Capital resources: the stock of capital available in a country and the cost of its deployment, Communications, Infrastructure resources: the characteristics and the cost of using the infrastructure available and Research facilities. Basic factors can provide only an initial advantage and they must be supported by advanced factors to maintain success. Japan is a country which lacks arable land and mineral deposits. Large pool of engineers - very vital for a

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manufacturing industry. Hence, Japan has high priced land and so its factory space is at a premium.

(b) Demand Conditions . The importance of demand conditions as a factor influencing competitive advantage stems from the fact that in a market economy the direction of production, that is, the kinds of goods which are produced, is determined by the needs of buyers. Home country Demand plays an important role as it enables better understand the needs and desires of the customers, shapes the attributes of domestic ally made products and creates pressure for innovation and quality. The sources of this influence within the context of home demand are divided into three broad attributes: the composition of home demand, the size and pattern of growth of home demand, and the mechanisms by which a nation’s domestic preferences are transmitted to foreign markets. For example, the Japanese camera industry which caters to a sophisticated and knowledgeable local market.

(c) Related and Supporting Industries . When trying to determine the sources of competitive advantage in an industry, The presence of suppliers or related industries is advantageous as the advantages of investment in advanced factors of production viz communications infrastructure, research facilities also extend to the supporting industries. It also creates clusters of supporting industries, thereby achieving a strong competitive position internationally. For example Silicon Valley.

(d) Firm Strategy, Structure, and Rivalry . Closing the circle of factors which determine the existence of competitive advantage it is necessary to consider the context in which firms are created, organized and managed as well as the nature of domestic rivalry. The goals, strategies, and ways of organizing firms in industries are widely influenced by national circumstances. Domestic rivalry creates pressure to innovate, improve quality, and reduce costs which in turn helps create world-class competitors. Germany tends to have hierarchical management structures composed of managers with strong technical backgrounds.

(e) Porter suggested that the a/m attributes constituted a diamond and he contended that firms are most likely to succeed in industries where the diamond is most favourable. He also stated that the diamond is a mutually reinforcing system and the effect of one attribute depends on the state of others. For example, favourable demand conditions will not result in a competitive advantage unless the state of rivalry is enough to elicit a response from the firms.

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Question 2. Explain Hofstede’s Cultural dimension Answer.1. Hofstede’s Cultural Dimension . Geert Hofstede is a Dutch social psychologist and anthropologist who has studied the interactions between cultures. Professor Hofstede carried out a detailed study of how values in the workplace are influenced by culture. According to Dr. Geert Hofstede, ‘Culture is more often a source of conflict than of synergy. Cultural differences are a trouble and always a disaster.’ One of his most notable accomplishments is the establishment of the cultural dimensions theory, which provides a systematic framework for assessing the differences between nations and cultures. He established a model using the results of the study which identifies four dimensions to differentiate cultures. Later, a fifth dimension called ‘long-term outlook’ was added. The following are the five cultural dimensions:-

(a) Power-Distance Index . Power distance is the extent to which the less powerful members of organizations and institutions accept and expect that power is distributed unequally.” This dimension does measure the level of equality or inequality between individuals in a nation’s society. High power-distance scores mean that less powerful members of the society accept their place and realize the existence of formal hierarchical positions and that inequality of power and wealth has been allowed to grow within the society. Low power-distance scores mean that a culture expects and accepts that power relations are democratic and members are viewed as equals. Such a society de-emphasises the differences between its people’s power and wealth. Countries with high PDI index are Arab countries, Russia, India and China. Those with low score are Australia and Japan.

(b) Individualism vs. Collectivism : It is the degree to which individuals are integrated into groups. This dimension has no political connotation and refers to the group rather than the individual and focuses on the extent to which the society reinforces individual or collective achievement and interpersonal relationships. A high individualism ranking depicts that individuality and individual rights are dominant within the society and the in these societies form a larger number of looser relationships. A low individualism ranking characterises societies of a more collective nature with close links between individuals. These cultures support extended families and collectives where everyone takes responsibility for fellow members of their group. Asian and African countries like Indonesia and Colombia have low individualism and Western countries, Canada and Hungary have high individualism.

(c) Uncertainty-Avoidance Index . This depicts the society’s tolerance for uncertainty and ambiguity.” This is a dimension that measures the way a society deals with unknown situations, unexpected events, and the stress of change. Cultures that score high on this index are less tolerant of change and tend to minimize the anxiety of the unknown by implementing rigid rules, regulations, and/or laws. These are rule-oriented societies that incorporates rules, regulations, laws, and controls are created to minimise the amount of uncertainty Societies that score low on this index are more open to change and have fewer rules and laws and more loose guidelines. Such a society is less rule-oriented, readily agrees to changes, and takes greater risks. Latin American countries, Germany, Belgium, Japan and Eastern Europe score high on this. Countries with low UAI score are Sweden, Denmark and China.

(d) Masculinity vs. Femininity . This shows the distribution of emotional roles between the genders and the extent to which the level of importance a culture places on stereotypically masculine values such as assertiveness, ambition, power, and materialism as well as stereotypically feminine values such as an emphasis on human relationships. Cultures that are high on the masculinity scale generally have more prominent differences between genders and tend to be more competitive and

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ambitious. Those that score low on this dimension have fewer differences between genders and place a higher value on relationship building. Countries like like Japan, Venezuela and Hungary have a high masculinity index and those like Norway and Sweden have a lower index.

Question 3. “An economic union comprises of a common market and a custom union.” Explain.Answer.1. There are five levels Of Regional Economic Integration:-

(a) Free Trade Area

(b) Customs Union

(c) Common Market

(d) Economic Union

(e) Political Union

2. An economic union is the fourth level of integration and is a type of trade bloc which is composed of a common market between members with a customs union ie a common trade policy between non-members, but where members are free to pursue independent macro-economic policies.

(a) Common Market . Services and capital are free to move within member countries, expanding scale economies and comparative advantages. However, each national market has its own regulations such as product standards.

(b) Custom Union . Sets common external tariffs among member countries, implying that the same tariffs are applied to third countries; a common trade regime is achieved. Custom unions are particularly useful to level the competitive playing field and address the problem of re-exports (using preferential tariffs in one country to enter another country).

3. The participant countries have both common policies on product regulation, freedom of movement of goods along with a common taxing method for imports from non-member countries, services and the factors of production (capital and labour) and a common external trade policy. The purpose of an economic union is to promote closer cultural and political ties while increasing the economic efficiency between the member countries. Economic unions are established by means of a formal intergovernmental legal agreement among independent countries with the intention of fostering greater economic integration. The members of an economic union share some elements associated with their national economic jurisdictions.

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Question 4. Explain the components of International Financial Management.Answer 1. International Financial Management (IFM) came into existence when the countries all over the world started opening their doors to each other. This phenomenon is also called liberalization. The components like foreign exchange market, foreign currency derivatives, international monetary markets and international financial markets which are essential to the international financial management, are discussed below:-

(a) Foreign Exchange Market. These markets facilitates the participants to obtain, trade, exchange and speculate foreign currency. They consists of banks, central banks, commercial companies, hedge funds, investment management firms and retail foreign exchange brokers and investors. Such a market is considered to be the leading financial market in the world. It is vital to realise that the foreign exchange is not a single exchange, but is created from a global network of computers that connects the participants from all over the world. The foreign exchange market is quite big and includes various functions including funding of cross-border investment, loans, trade in goods, trade in services and currency speculation. The participant in a foreign exchange market will normally ask for a price. The trading in the foreign exchange market may take place as outright cash or foreign exchange currency deals that take place on the date of the deal, next day ie foreign exchange currency deals that take place on the next working day, swap , which is simultaneous sale and purchase of identical amounts of currency for different maturities and spot’ and ‘forward’ contracts ie a binding obligation to buy or sell a definite amount of foreign currency at the pre-agreed rate of exchange, on or before a certain date.

(b) Foreign Currency Derivatives . Any financial instrument that locks in a future foreign exchange rate. It is a financial contract that seeks to swap two currencies at a predetermined rate. It can also be termed as the agreement where the value can be determined from the rate of exchange of two currencies at the spot. These can be used by currency or forex traders, as well as large multinational corporations. The latter often uses these products when they expect to receive large amounts of money in the future but want to hedge their exposure to currency exchange risk. Financial instruments that fall into this category include: currency options contracts, currency swaps, forward contracts and futures contracts. The agreement undertaken to exchange cash flow streams in one currency for cash flow streams in another currency in future is provided by currency swaps. These will help to increase the funds of foreign currency from the cheapest sources. Some of the risks associated with currency derivatives are:

(i) Credit risk takes place, arising from the parties involved in a contract.

(ii) Market risk occurs due to adverse moves in the overall market.

(iii) Liquidity risks occur due to the requirement of available counterparties to take the other side of the trade.

(iv) Settlement risks similar to the credit risks occur when the parties involved in the contract fail to provide the currency at the agreed time.

(v) Operational risks are one of the biggest risks that occur in trading derivatives due to human error.

(vi) Legal risks pertain to the counterparties of currency swaps that go into receivership while the swap is taking place.

(c) International Monetary System . Any country needs to have its own monetary system and an authority to maintain order in the system, and facilitate trade and investment. India has its own monetary policy, and the Reserve Bank of

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India (RBI) administers it. The same is the case with world, its needs a monetary system to promote trade and investment across the countries. International monetary system exists since 1944. The International Monetary Fund (IMF) and the World Bank have been maintaining order in the international monetary system and general economic development respectively. International monetary systems provide the mode of payment acceptable between buyers and sellers of different nationality, with addition to deferred payment. The global balance can be corrected by providing sufficient liquidity for the variations occurring in trade. Thereby it can be operated successfully.

(d) International Financial Markets . International financial market born in mid-fifties and gradually grown in size and scope. International financial markets comprises of international banks, Eurocurrency market, Eurobond market, and international stock market. International banks play a crucial role in financing international business by acting as both commercial banks and investment banks. Most international banking is undertaken through reciprocal correspondent relationships between banks located in different countries. These markets are independent markets that are not under the authority of any one country and the financial markets of each country are linked by international foreign markets. What governs the heart of the international financial market is the market where international trade and investment dominates foreign currency. As a result the purchase of currency precedes the purchase of services and goods. The purpose of international securities markets, international capital markets, international money markets and foreign currency markets is stated below:

(i) The foreign currency markets – An international market that has no central place for trading to take place or is familiar in structure.

(ii) International money markets – A market for accounts, deposits or deposits that include maturities of one year or less may be conventionally said to be an international money market.

(iii) International capital markets – They are markets of individual countries, which are linked by international capital. .

(iv) International security markets – The continued opportunity to provide large portion of the international financial needs of the government and business have allowed the banks to experience the greatest growth in the past decade. The international security market includes private placements, bonds and equities.

Question 5. What are the differences between International Accounting Standards and Domestic Accounting Standards?Answer

1. Differences between IAS and DAS. Different countries whether domestic or international, have different accounting standards. A common belief is that these differences reduce the quality and importance of accounting information. Accounting standards determine the financial reporting quality and provide separately verified information about an organisation's financial performance to investors’ creditors. However, domestic businesses are not affected by differences in accounting methods as the accounting system of a domestic organisation must meet the specialised and regulatory standards of its home country. On the other hand, an MNC and its subsidiaries must meet differing accounting and auditing standards of all the countries in which it operates, which leads to a need for comparability between businesses in the group. In order to successfully manage and organise their operations, local managers require accounting information, which should be prepared according to the local accounting concepts and denomination in the local currency. Yet, for financial controllers, to measure the foreign subsidiary’s

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performance and worth, the subsidiary’s accounts must be translated into the organisation’s home currency. The organisation also has to pay taxes to the countries where it does business, based on the accounting statements prepared in these countries. Besides this, when a parent corporation tries to combine the accounting records of its subsidiaries to produce consolidated financial statements, extra complexities occur because of the changes in the value of the host and home currencies. There are many differences between International Accounting Standards (IAS) and Domestic Accounting Standards (DAS). On the basis of difference between the two, two indices, namely 'divergence' and 'absence', are created. Absence is the difference between DAS and IAS; the rules on certain accounting issues are missed out in DAS and covered in IAS. Divergence represents the differences between DAS and IAS; the rules on the same accounting issue differ in DAS and IAS.

2. Measurement of differences between IAS and DAS . You can measure the differences between IAS and DAS in the following way:-

(a) Literature on International Accounting Differences . Various data sources have been used to measure international accounting differences in prior literature. Most of the prior studies interpret international accounting differences as different options adopted by different nations for the same accounting issues, which corresponds to our “divergence” concept. Referring to earlier reports on international accounting could give more information about the subject. Most of the earlier reports understand international accounting differences as various options adopted by nations for the similar accounting problems, which correspond to divergence concept.

(b) Framework of Analysis . Links between variations in accounting standards and financial reporting quality of various countries could be clearly seen from the reports published earlier. We should consider the institutional determinants of accounting differences such as legal origin, governance structure, economic development, and equity market.

3. Implications of the Differnces . There are two implications of the differences between DAS and IAS ie on earnings management and on synchronicity of stock prices. The main findings indicate that “absence” creates an opportunity for more earnings management and exacerbates the synchronicity of stock prices. Greater synchronicity implies that the idiosyncratic component of the changes in prices is small, thus stock prices are mainly affected by market-wide stock price swings. This result is consistent with the theory that lack of transparency (opaqueness) leads to a high level of synchronicity. We also find that “divergence” between DAS and IAS as no effect on earnings management and is negatively related to the synchronicity of stock prices.

Question 6 Explain the key component of International Strategic management.Answer1. International Strategic Planning . Strategic planning involves the organized efforts of an organisation to successfully sustain its purposes for existing, craft for itself the direction that it needs to pursue, and take the direction to achieve its short-term and long-term goals. It is an important element in all kinds of organisations and is applied by governments, non-profit agencies, individuals and businesses. The concept of strategic management process in an MNC is similar to that of any other organisation. However, a major complicating factor is that before considering various strategic options, the strategic management process has to analyse and understand the environmental needs from a regional and country perspective. In the approach to strategic planning the first step is to accurately assess where the entity is today, with respect to its ability and resources, to recognise where the organisation would like to reach at some specific point of time in the future, by efficiently setting goals and objectives that it needs to accomplish and choose how to successfully progress from the conditions of today and methodically work toward

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those goals in a structured and logical manner. The various componente of a Strategic Plan are discussed in the succeeding paragraphs.

2. Types of Planning . Any business plan can be classified into three types. They are:

(a) Strategic Planning . It is a long-term process that the business owners utilise to unveil their business’ vision and mission. It also determines a roadmap for achieving their goals. Strategic planning fulfils the mission and the overall goals of the firm.

(b) Intermediate Planning . This is a short-term planning process for six months to two years. It outlines the manner in which a strategic plan is pursued. Intermediate plans are often used for campaigns with the purpose and goal of supporting the trades’ long-term goals.

(c) Short-term Planning . This planning process involves planning for few weeks or at least for a year. It involves specifying out the functioning of a strategic plan on a daily basis. Resources are allocated for business management and development that takes place daily within the strategic plan.

3. Gap Analysis . A GAP analysis is a simple tool that helps to identify methods to close the performance gaps. For this the planners must be fully aware of the current affairs and the required future state. The performance gap is closed by modifying resources from activities to be terminated to activities to be started. If there is uncertainty that the initial gap cannot be closed, then the feasibility of the required future state must be reconsidered. Businesses implement gap analysis to accomplish company-wide goals, or those for a specific department or area. Gap analysis also help businesses measure their possible profitability of a goal, which helps the management and staff to understand the plans laid out in the analysis as well as stay eager about it.

4. Top-down vs. Bottom-up Planning (a) Top-down Planning . Top-down planning is a common strategy that is used for project planning, which helps maintain the decision making process at the senior level. Goals and allowances are established at the highest level. Senior-level managers have to be very specific when laying out expectations because the people following the plan are not involved in the planning process. It is very important to keep the morale of the employees high and motivate them to perform the job. Since employees are not included in any of the decision making processes, they are motivated only through fear or incentives. Management must choose techniques to align projects and goals with top-down planning. Management alone is held responsible for the plans set and the end result. The benefit of talented employees with prior experience on definite aspects of the project are not utilised based on the assumption that the management can plan and perform a project better without the inputs from these employees. Some think that the top-down planning process is the right way to make a plan, and that the plan development is not important. It permits the management to segregate a project into steps, and then break the work into smaller executable parts of the project. Simultaneously, the work that is broken down is analysed until all the steps could be studied, due-dates are precisely assigned, and then parts of the project are given to employees. However, the focus is on long-term goals and the short-term and uncertain goals can get lost. This approach is best applicable for small projects. Top-down planning helps to:-

(i) Determine all the goals at the initial stage of the process.

(ii) Identify the lack of ground level staff participation.

(iii) Estimate the inflexibility.

(iv) Find how management imposes the processes.

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(v) Determine the lack of motivation.

(vi) Find whether the staffs feel that their input is valued or not

(b) Bottom-up Planning . Bottom-up planning is commonly referred to as tactics. With bottom-up planning, an organisation gives its project deeper focus because each organisation has a huge number of employees involved, and each employee is an expert in their own area. Team members work side-by-side and contribute during each stage of the process. Plans are developed at the lowest levels, and then passed on to each of the subsequent higher levels. Finally, it then reaches the senior management for approval. Lower-level employees take personal interest in a plan that they are involved in planning. Employees are more encouraged which in turn improves their morale. Project managers are responsible for the successful completion of the project. Bottom-up planning helps to:

(i) As there are no long term vision here.

(ii) Encourage teamwork.

(iii) Estimate flexibility.

(iv) Determine whether team motivation is of high level.

(v) Identify whether the project is team driven. • Find whether the staff feels valued or not.

5. Finally, a combination of these two project management methods is most effective. Using the positive aspects of each, the organisation can align each step so that the requirements of the project are met. An organisation can determine the top requirements of the project and allow accountability to get down with the lower levels. With this combination, the vision of senior management with the skills of lower level employees is merged. This helps in completion of the project more efficiently using the best employees of the organisation.