When it comes to business agreements,
you will realize that domestic business looks at business agreement in
relations to issues at home such as pricing issues, quantities, logistics and
delivery of goods and services and other matters that may have an impact on
domestic business operations.
When it comes to international business
operations you will come across issues such as;
·
Currency to be used in
the international business transactions.
·
Credit worthiness of
the importer.
·
Acceptable methods of
payment.
·
Arranging finance.
Currency
to be used;
Selection of currency for settlement of
trade is a very important issue in international finance because when it comes
to export and import of products, you will notices that importers would prefer
to receive payment in his home currency while the exporter would prefer to pay
in his home currency. There are terms that you would come across when it comes
to payment of goods and services by international business. Such terms used are
weak currency and hard currency. When a currency is weak exporter would prefer
to be paid in hard currencies therefore most payments are done in US Dollars,
UK pounds, Japanese Yen etc. These currencies are strong. The exports of most
developing countries are made in US Dollars.
Credit
Worthiness of the Importer
Credit worthiness of importers should be
first established by the exporters because of certain risks and therefore it is
important to check out the credit rating of your importer. Does the importer
have a good credit rating with the bank? Does the importer have the financial
capabilities to pay for the imported goods? Is the imported company of
reputable standing etc.
Credit worthiness of importers should be
first established by exporting firms before exports are made. This can be done
by seeking independent information from the bank or any reputable firm, (Banks,
financial institution, other reputable firms etc.) Once such information is
received by the exporters, there should be some good understanding between both
parties on the type or method of payment to be used.
Methods
of Payment
Both exporter and importer should agree
on the particular of payment, after assessing the importers credit worthiness.
The methods of payment that can be used are as follows;
·
Payment
in Advance - Most exporters prefers the advance
payment prior to shipment as this arrangement does not involve risks.
·
Open
Accounts – Under Open Account the importer first
receives the goods and then arranges for the payment. Hence it is the safest
form of payment from the point of view of the importer however, from exporter’s
point of view it involves risks in getting the goods delivered per the order.
·
Documentary
Collection – Due to risks and problems involved in
advance payment and open account, international financial institutions and
banks have come up with a number of instruments to facilitate payments. Example
of documentary instruments are; Sight Bill of Exchange and Time Bill of
Exchange.
o Sight
bill of exchange requires payment immediately after the transfer of title of
the good to the importer by the exporter. The importers bank after receiving
the Bill of Landing and sight bill of exchange arranges payment immediately.
o Time
bill of exchange requires the importer to arrange for the payment after
sometimes (60 days or 90 days) receiving the possession of goods. Importer
accepts the goods by Trade Acceptance documents and payment is arranged
accordingly.
·
Letter
of Credit (LOC) – This instrument is carried out
to avoid the risk involved in other methods of payment. LOC is issued by bank
wherein the bank promises the exporter to pay upon receiving the proof that the
exporter completed all formalities specified in the documents.
·
Credit
Cards – Are used for small international
business transactions by the market intermediaries like retailers and also by
customers. Examples; Visa Cards, American Express and Master Cards.
·
Counter
Trade – Is an arrangement to pay for import
of goods and services with something other than cash. (Goods for Goods).
International
Financial Environment
When discussing the International
Financial Environment, you will realize that the extent of influences covers a
wide range of issues from size of business, pattern of business, and the
direction of business. Let us look at some of the factors that you may come
across;
Exchange
Rates – were determined on the basis of the
value of metal contained in the coins of two countries. This system was
referred to as the commodity specie standard. This system was followed by gold
standard.
Gold Standard – (Please do a research on
this method. It was introduced and adopted by several countries, and later
abolished).
Exchange
rate Regime since 1973
·
Floating-rate
System – Market forces determines the exchange
rates of currencies under floating rate system.
·
Pegging
of Currency – A developing country peg its
currency either to a strong currency or to a currency of a country with which
it has a large share of trade.
·
Crawling
Peg – This is a hybrid of fixed rate and
floating rate. The exchange rate of a currency with which it is pegged is
stable in the short-run but changes gradually over a period of time in order to
reflect the change in the market.
·
Target-zone
Arrangement – Exchange rates are fixed with
respect to the currencies of the countries of a particular zone and the
exchange rates float with respect to the countries outside the zone.
Theories of Exchange Rate Behaviour
The theories of exchange rate behaviour
are classified as follows;
·
Balance
of Payment Approach – According to this
theory, the inflow of foreign exchange takes place under the following two
situations;
o Through
export of goods and services when the price level in the domestic country is
lower compared to that in foreign countries.
o Through
foreign investment when the interest rates in the domestic country are higher
than that in the foreign countries.
·
Monetary
Approach of Flexible-price Version – According to
this approach, the exchange rate between two currencies is fixed on the basis
of demand and supply of money in the two countries.
·
Monetary
Approach of Sticky-price Version – This theory
proposes that increase in money supply results in decline in value of domestic
currency.
o Money
supply in a country is positively related to market interest rate.
o Purchasing
power parity theory applies in the long-run and as such the expected inflation
differential changes influence the exchange rates.
·
Portfolio
Balance Approach – this theory emphasises that the
exchange rate is determined based on not only inflow and outflow of foreign
exchange, but also the holding of financial assets like domestic and foreign
bonds.
Global
Capital Structure
Capital is the main resources that
businesses needs to operate and carry out business activities so regardless of
whether you are a domestic firm or an international firm, capital resources is
needed. Capita provided by the owners
are known as equity capital. Capital that is secured from other sources such as
in the form of loans etc. is known as debt equity.
As business firms grow and expand their
operations globally, they should carefully determine the level of equity
capital and debt capital as and when it is required and in most cases it
depends on the expansion strategies.
Some international firms make use of the
accumulated profits and reserves to meet the increase demand for capital.
Global
Cash Flow Management
When discussing cash flow management,
you are dealing with short-term financing. In term of international business,
MNCs have to plan, organize and monitor the cash inflow and cash outflow of its
different operations to ensure there is sufficient capital to continue its
operations on a daily basis and this is where the issue of cash flow management
come in.
Operating cash flows include direct and
indirect cash flows. Direct cash flows include inflows and outflows.
It is important that there is cash
flowing into the business because this is necessary for the day to day business
activities in order to pay for raw materials, remunerations, royalties and
commissions and other direct and indirect costs that may be incurred by any
businesses.
For international business, cash flows
is multi directional meaning cash inflows from a Japanese business operations
can sometimes be used for accounts payables in China etc.
C ash
Flow Management
Cash
Flow Management
Cash flow can be managed either through
a centralized treasury operation or through its subsidiary or between
subsidiaries and among subsidiaries and the parent company. A process that some
companies use is known as Netting. When
the cash flows between parent company and its subsidiary, between subsidiary
and among subsidiary takes place, the two-way cash flows are netted against
one another. Netting enables the companies to pay the net balances only.
Cash Pooling is another process that
MNCs uses and this when MNCs and their units operating across the countries
need to maintain larger sums of cash in order to have liquidity. Given the fact
that large amount of cash increases cost, MNCs pool cash and capital of all its
units in order to economise the cash and capital balance and flow.
Cash flow can be managed either through
a centralized treasury operation or through its subsidiary or between
subsidiaries and among subsidiaries and the parent company. When the cash flows
between parent company and its subsidiary, between subsidiary and among
subsidiary takes place, the two-way cash flows are netted against one
another. Netting enables the companies to pay the
net balances only.
Foreign
Exchange
As discussed in the beginning of this
topic, the importing country pays money to the exporting country in return for
goods and services in either the domestic currency or in a hard currency. The
currency which is use in the payment transaction is called the foreign
exchange. This foreign exchange is the money in one country for money or credit
or goods or services in another country.
Foreign exchange includes foreign
currency, foreign cheques and foreign drafts. Foreign exchange is bought and
sold in foreign exchange markets. Components of foreign exchange markets
include the following; Buyers, Sellers, and Intermediaries.
Exchange
Rate Determination
The transactions in the foreign exchange
markets (buying and selling of foreign currencies) take place at a rate which
is called an “exchange rate”.
Exchange rates are the price paid in the
home currency for a unit of foreign currency and this can be quoted in two
ways;
·
One unit of foreign
money to a number of units of domestic currency.
·
A certain number of
units of foreign currency to one unit of domestic currency
Demand for foreign exchange is
determines by the country’s;
·
Import of Goods and
Services.
·
Investment in foreign
countries.
·
Other payments involved
in international transactions.
·
Other types of outflow
of foreign capital.
Supply of foreign exchange is due to the
following;
·
Country export of goods
and services to foreign countries.
·
Inflow of foreign
capital.
·
Payment made by the
foreign government.
·
Other types of inflow
of foreign capital.
Fixed
and Flexible Exchange Rates
Fixed Exchange Rates – IMF member
countries used to fix or determine exchange rates by pegging operations and/or
resorting to exchange control. Under this system, the governments used to fix
the exchange rate and the central bank to operate it by creating ‘exchange
stabilization fund’. The central bank of the country purchases the foreign currency
when the exchange rate falls and sells the foreign exchange when the exchange
rate increases. (Rao, 2012:388)
Why
do countries go for the Fixed Exchange Rate System?
Advantages
why countries are go for Fixed Exchange
Rates systems is because of the following reasons; (Fixed Exchange Rates).
·
Fixed exchange rates
ensure certainty and confidence and thereby promote international business.
·
Fixed exchange rates promotes
long-term investments by various investors across the globe.
·
Most of the world
currency areas like US dollar areas and sterling pound areas prefer fixed
exchange rates.
·
Fixed exchange rates
results in economic stabilization.
·
Fixed exchange rates
stabilize international business and avoid foreign exchange risks to a greater
extent.
Few
Disadvantages (Fixed Exchange Rates)
·
IMF permits occasional
changes due to problems with exchange rate system. System or can be changed to ‘managed
flexibility system’. The Managed Flexible System needs large foreign exchange reserves
to buy or sell foreign exchange in order to manage the exchange rates.
·
Fixed Exchange Rate
system may result in a large-scale destabilizing speculation in foreign exchange
markets.
·
Long-term foreign
capital may not be attracted as the exchange rates are not pegged permanently.
·
Most of the economies
in recent years are liberalized and globalized. These economies prefer flexible
exchange rate system.
Flexible
Exchange Rates
Flexible exchange rates are also called
floating or fluctuation exchange rates and it is determined by market forces
like demand and supply of foreign exchange. In this instances you will find
that the government or monetary authority try not to interfere or intervene in
the process.
Advantages
·
This system is simple
to operate and does not result in deficit or surplus of foreign exchange. The
exchange rate moves automatically and freely.
·
The adjustment of
exchange rate under this system is a continuous process.
·
The system helps for
the promotion of foreign trade
·
This system permits the
existence of free trade and convertible currencies on a continuous basis.
·
This system eliminates
the expenditure of maintenance of official foreign exchange reserves and
operation of the fixed exchange system
Disadvantages
·
Market mechanism may
fail to bring about an appropriate exchange rate and the equilibrium may fail
to give the necessary signals to correct the balance of payments position.
·
It is difficult to
define a flexible exchange rate.
·
Under the flexible rate
system, speculation adversely influences fluctuations in supply and demand for
foreign exchange
·
Under this system a
reduction in exchange rates leads to a vicious circle of inflation.
Students are encouraged to read Chapter
16 Textbook; International Business, (Rao 2012) further into the Foreign
Exchange Markets and to understand the following;
Functions
of Foreign Exchange Market
·
Transfer of Purchasing
Power
·
Credit for
International Business
·
Minimize Exchange Rate
Risks
Nature of Foreign Exchange Market
·
Widespread
Geographically
·
All Time Operation
·
Market Participation
Students please read the recommended
text books on the different topic.
Source:
International Business Environment by
Francis Cherunilam, (2009) Himalaya Publishing House.
International Business by P Subba Rao,
(2012) Himalaya Publishing House.
Business Ethics by Andrew Crane, Dick
Matten, (2007) Oxford University Press or other related text books and
materials.
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