Page 1 of 2. MBA IV Semester Examination, 2013. International Financial
Management (AR -7390). Model Answer. Section – A. (Short Answer Type
Questions).
MBA IV Semester Examination, 2013 International Financial Management (AR -7390) Model Answer 1.
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Section – A (Short Answer Type Questions) Ethnocentric firms are those that adopt home-market oriented policy and seldom distinguish between the domestic operation and the global operation policies. Polycentric firms adopt policies according to the host country Geocentric firms maintain a balance between the home –market policies and host- market oriented policies. Monetary movement of gold is the sale or purchase that influences the international monetary reserves. Non-monetary sale or purchase of gold is done for industrial purposes that is shown in the current account either separately or along with the trade in merchandise. According to the classical view the balance of payment disequilibrium is self-adjusting. According to the classical approach, an increase in money supply raises domestic prices, exports become uncompetitive, export earnings drop, foreign goods become cheaper and imports rise. As a result, the current account balance goes deficit. Precious metal flows out of the country to finance imports, the quantity of money drops and that lowers the price level. Lower prices in the economy lead to increased exports resulting in trade balance regaining equilibrium. Smithsonian agreement took place in 1971 to restore stability in international monetary system. Smithsonian arrangement realigned parity through devaluation of US dollar and widened the fluctuation band. Exercise rate or price is the price at which options are exercised, this is also known as the strike price. Spot rate or price refers to the rate at which transactions take place in the spot market. The Purchasing power Parity Theory shows that the exchange rate is determined by the purchasing power of the two currencies. If e is the exchange rate and PA and PB are the purchasing power of two currencies, A and B, the equation can be written as e = PA/ PB Balance-sheet hedge is a technique of managing translation exposure. Balance-sheet hedge removes mismatch between liabilities and assets through creating liabilities/assets. The NPV rule is better than the IRR rule in capital budgeting. When projects of different lives are considered, the IRR rule inflates the desirability of short-life projects. Secondly, IRR tends to be lower on projects with a longer gestation period, even when, NPV remains larger. Thirdly, while computing IRR, there is possibility of more than one solution. Portfolio risk is measured by the variance of portfolio return. Symbolically
Where is the correlation between the returns on assets i and j 10. Asian Development Bank was started in August, 1966. The ADB provides financial and technical assistance for economic development of developing member countries such as i. Loan and equity investments ii. Technical assistance for preparing and carrying out development projects iii. Helps mobilize additional resources within the region and helps attract investment from outside etc. SECTION B Hints for Long- Answer Type Questions 11. International Financial Management deals with financial aspects of international business. Nature of IFM is similar to domestic financial management with additional complication due to involvement of foreign currencies. The nature and scope includes BOP, exchange rate determination, risk management besides all the financial functions of domestic financial management. 12. Balance of payments is a statement listing receipts and payments in international transactions of a country. Components of balance of payments are current account, capital account, errors and omissions and official reserves. The student has to provide details of the above components. Elasticity approach explains that Page 1 of 2
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depreciation in the currency leads to greater export and diminished import and the resultant squeeze in trade deficit. Students have to elaborate this point in their answer. International monetary system consists of the laws, rules, monetary standards, instruments, and institutions that facilitate international trade and cross-border flow of funds. Students have to elaborate this concept. Advantages of Fixed Exchange Rate System include stability and certainty in exchange rates, create confidence in currency, and facilitates domestic economic stabilization. Deficiencies of this system include: the exchange rate is determined by market authorities and not by market forces, exchange rate is determined by extraneous factors, rules of fixed exchange rates are bypassed by governments, inflexible etc. Advantages of floating exchange rate system are: exchange rate is market determined, signal of a strong economic system, attract foreign investment, no difficulties for tariffs, subsidies and quotas etc. Economic exposure refers to potential changes in all future cash flows of a firm that result from unanticipated changes in exchange rates It includes transaction exposure and operating exposure. Transaction exposure can be managed by hedging techniques as well as operational techniques. Hedging techniques include forwards, money market hedges, futures, options and swaps. Operational techniques include exposure netting, leading and lagging and currency of invoicing. The management of operating exposure involves decision making with respect to plant location, sourcing of raw material, production technology, pricing of products, product development and selection of markets etc. The foreign exchange rate is determined by several forces, which known as demand forces and supply forces. There are several factors that influence the exchange rate through their effects on the currency demand and supply. Important factors that determine the exchange rate include inflation rate, economic growth rate, interest rate, political factors, social factors and government controls etc. Currency options are derivative contracts. Currency option contract confers on option-buyer privilege of not exercising the contract when exchange rate is not in his favor. Factors which determine the value of a currency option are a. Changes in forward rate b. Changes in spot rate c. Time to maturity d. Volatility in exchange rate e. Interest rate differential f. Alternative strike price Students are expected to briefly discuss the purpose of the World Bank, its structure and basic functions. Students are expected to write about the type of loan such as Investment loans, adjustment loans and enclave loans. Students are expected to elaborate and expand the following ideas: a. Fisher Effect explains that nominal interest rate is the amalgam of real interest rate and inflation rate. The Fisher effect states that whenever an investor thinks of an investment, he is interested in a particular nominal interest rate which covers both the expected inflation and the required real interest rate. b. Bretton Woods System: The main aim of the meeting of representatives of 44 nations at Bretton Woods was to bring about international financial order through an effective monetary system. The Bretton Woods system required that each country should fix a par value of its currency in relation to the U.S. dollar, which was pegged to gold at USD 35 per ounce. c. Absorption approach is one of the earliest approaches representing the Keynesian view. Absorption approach treats balance of trade as a residual given by the difference between what the economy produces and what it takes for domestic use or what it absorbs. Absorption means the sum of consumption, investment and governmental spending.
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