INTERNATIONAL FINANCE & CONTEMPORARY

ISSUES

[Link] (Hons) Semester 4 | Unit 5 Comprehensive Study Notes

Module 1: Foreign Exchange Dynamics

PREVIOUS YEAR QUESTION / CONCEPT CHECK

Qus foreign exchange market + Role of gout. in determination of foreign Exchange Rate +
features + functions .

1. Foreign Exchange Market

The foreign exchange market is the global market for the exchange of one currency for another.
It is made up of banks, commercial companies, central banks, investment management firms,
hedge funds, and retail forex brokers and investors. Participants buy, sell, exchange, and
speculate on currencies. Brokers (dealers) are heavily involved in the large trading of forex.

• Functions of the Foreign Exchange Market:

◦ Transfer Function: The basic function is to facilitate the conversion of one currency into
another. It accomplishes the transfer of purchasing power between two countries through
instruments like bank drafts, foreign bills, and telegraphic transfers. It carries out
international payments by clearing debts in both directions simultaneously.

◦ Credit Function: Provides credit, both national and international, to promote foreign
trade. When foreign bills of exchange are used, credit for about 3 months till maturity is
often required.

◦ Hedging Function: Facilities are provided to hedge foreign exchange risks. Forward
contracts (normally for 3 months) allow buying/selling of foreign exchange at a fixed
future date at an agreed price, making it possible to ignore likely exchange rate changes.

• Features: Large trading volumes, continuous operation, geographical dispersion, and highly
liquid markets (extrapolated from syllabus concepts matching the notes' placeholder).

2. Foreign Exchange Rates

An exchange rate defines the price of a nation's currency in terms of another currency. It has
two components: domestic currency and foreign currency.

• Direct Quotation: The price of a unit of foreign currency is expressed in terms of the
domestic currency (Foreign currency is the base currency, domestic is counter).

• Indirect Quotation: The price of a unit of domestic currency is expressed in terms of the
foreign currency (Domestic currency is the base currency, foreign is counter).

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 • Cross Rate: An exchange rate that does not have the domestic currency as one of the two
components.

• Note: Most exchange rates use the US dollar as the base, with exceptions like the Euro and
Commonwealth currencies (British Pound, Australian/New Zealand Dollar).

PREVIOUS YEAR QUESTION / CONCEPT CHECK

Qus Exchange Rate system . OR Fixed exchange Rate system + Adv. & disadvantages. OR
Flexible exchange Rate system → Diff. btw fixed & flexible exchange rate system.

3. Exchange Rate Systems

A. Fixed Exchange Rate System

A currency system in which governments try to maintain a currency value that is constant
against a specific currency or good (like gold). The central bank remains committed to buying
and selling its currency at a fixed price, maintaining reserves of foreign currencies and gold to
intervene in the market.

• Advantages: Avoids currency fluctuations, encourages investment, and keeps inflation low.

• Disadvantages: Might hinder macro-economic objectives, less flexibility, requires high

interest rates, and difficulty in keeping the value of currency constant.

B. Floating (Flexible) Exchange Rate System

A regime wherein a currency's value is allowed to fluctuate according to the foreign exchange
market (supply and demand). Many economists believe it is best because it automatically
adjusts to economic circumstances and dampens the impact of shocks. Example: US Dollar.

• Managed Float: A true free float is rare. Often, central banks attempt to keep currency
relationships within a predetermined range by intervening (buying/selling).

• Disadvantage: Gives rise to unpredictability and volatility.

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 BASIS FIXED EXCHANGE RATE FLEXIBLE EXCHANGE RATE

Meaning Rate fixed by the government and Rate of exchange that varies as
maintained at the same level. per market forces.

Determined by Government or Central Bank. Demand and supply forces.

Changes in Price Devaluation and Revaluation. Depreciation and Appreciation.

Speculation Takes place when there is rumor Very Common.

about a change in government policy.

Self-adjusting Operates through variation in supply Operates to remove external

mechanism of money, domestic interest rate, and instability by change in forex
price. rates.

PREVIOUS YEAR QUESTION / CONCEPT CHECK

Qus explain the different factors which affect exchange rate determination in the light of
different theories of exchange rate determination.

4. Factors Influencing Exchange Rates & Theories

Foreign exchange rates are constantly changing, influenced by economic, political, and social
factors. The primary determinants include:

• Inflation differential: A country with a higher inflation rate experiences a decrease in

currency value due to reduced purchasing power. Investors prefer countries with lower
inflation. (Aligns with Purchasing Power Parity Theory).

• Interest rates: Higher interest rates attract more foreign investment, increasing demand for
the currency and its value. Lower rates decrease demand. (Aligns with Interest Rate Parity
Theory).

• Deficits (Trade Balance): When a country imports more than it exports (trade deficit),
demand for its currency decreases, causing the exchange rate to decline. (Aligns with Balance
of Payments Theory).

• Debt: Countries with high debt are perceived as riskier, leading to decreased demand for
their currency.

• Import-Export: A trade surplus (exports > imports) increases demand for the currency,
raising the exchange rate.

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 Theory Visualization: Demand & Supply of Forex

Exchange Rate
S (Exports)

Equilibrium Rate

D (Imports)

Quantity of Foreign Currency

5. Role of Government in Determining Exchange Rate

Monetary authorities influence the foreign exchange market by buying and selling currencies to
manage excessive fluctuations and stabilize them. In a Managed Float, governments prevent
sudden large swings in currency value.
Example: The US government buying $1 billion worth of US dollars with British pounds to
artificially fix the value of the dollar in terms of the pound.

PREVIOUS YEAR QUESTION / CONCEPT CHECK

Qus spot rate vs. Forward Rate .

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6. Spot Rate vs. Forward Rate

CONCEPT SPOT RATE FORWARD RATE

Definition Price quoted for immediate Rate applicable to a financial

settlement on a commodity, security, transaction that will take place in
or currency. the future.

Timing Settlement normally occurs one or Settlement at a specific future date

two business days from the trade (e.g., in six months).
date.

Determinants Based on the value at the moment of Based on the spot rate, adjusted for
the quote (current market value, the cost of carry.
supply/demand).

Obligation Immediate transaction completion at Contractual obligation that must be

benchmark rate. honored regardless of the spot rate
at maturity.

PREVIOUS YEAR QUESTION / CONCEPT CHECK

Qus foreign exchange risks ? It is same as foreign exchange exposure ? Why ? Difference
between.

7. Foreign Exchange Risk vs. Exposure

• Foreign Exchange Risk: The risk of investment value changing due to changes in the
currency's exchange rate. It is the net potential gains or losses arising from exchange rate
changes. It affects businesses in export/import and international investors. Adverse
movements bring loss; favorable movements bring windfall profits.

• Foreign Exchange Exposure: The sensitivity of the real domestic currency value of assets,
liabilities, or operating incomes to unanticipated changes in exchange rates. It is the extent to
which transactions are denominated in currencies other than the reporting currency.

• The Key Difference: Exposure is what is at risk (the total value of assets/liabilities in foreign
currency). Risk is the variability or the excess/shortfall in cash flows arising on account of
those fluctuations.

Module 2: Foreign Investment (FDI & FPI)

Foreign Investment is capital flowing from one country to another. Investors take an
ownership stake in domestic companies, open new manufacturing plants, and drive job growth.

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 PREVIOUS YEAR QUESTION / CONCEPT CHECK

Qus foreign Investment ? Diff. btw FDI and FPI .

1. Direct vs. Indirect Investment (FDI vs. FPI)

FDI (FOREIGN DIRECT INVESTMENT) FPI (FOREIGN PORTFOLIO INVESTMENT)

Long term investment. Short term investment.

Involves investment in physical assets. Involves investment in financial assets

(stock exchange).

Aims to increase enterprise capacity, productivity, or Aims at increasing capital availability.

change management control.

Leads to technology transfer, access to markets, and Results only in capital inflows.
management inputs.

Flows into the primary market of the country. Flows into the secondary market of
the country.

Entry and exit is relatively difficult. Entry and exit is relatively easy.

Does not tend to be speculative. Tends to be speculative.

Eligible for profits of the company. Eligible for capital gain.

Direct impact on employment of labor and wages. No direct impact on employment of

labor and wages.

PREVIOUS YEAR QUESTION / CONCEPT CHECK

Qus FDI and its types . OR Greenfield investment & how is it different from brownfield
investment .

2. Types of FDI: Greenfield vs. Brownfield

FDI occurs when a company owns another company in a different country, or puts up physical
investment to build a facility in another country.

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 BASIS GREENFIELD INVESTMENT BROWNFIELD INVESTMENT

Meaning Setting up a new business/facility from Buying, leasing, or merging with

scratch in a foreign country. an existing facility/business.

Ownership Full control from the beginning. May involve partial control if only
Wholly owned subsidiary. part of the business is acquired.

Cost Generally higher maintenance and Usually lower establishment cost,

setup, as everything is built new. as infrastructure already exists.

Time to Takes longer to start operations Operations can begin quickly

Operate (construction, setup). (saves time).

Risk Level Higher risk (high risk, high return Lower risk, as business is already
principle). running.

Example Toyota building a new manufacturing Vodafone acquiring an existing

plant in India. telecom company in India.

Other Expands brand goodwill, exact modern No need for fresh regulatory
Advantages equipment, economies of scale, approvals, lower staffing/training
subsidies from developing nations. cost, useful for modifications.

PREVIOUS YEAR QUESTION / CONCEPT CHECK

Qus Does FDI always benefit a country ? FDI - benefits & drawbacks.
Qus Measures taken by govt. To promote FDI and its impact on home / host country.

3. Impact of FDI: Host vs. Home Country

Impact on Host Country (Receiving Investment)

• Benefits: Creates jobs, drives economic growth, infrastructure development, promotes

investment in key areas, access to international markets/supply chains, brings new
technologies, capital inflow, increases exports, and promotes financial services.

• Costs/Drawbacks: Threat to domestic/small firms (unfair competition), pollution/

environmental degradation, cultural erosion, inflation, political corruption, economic
colonialism, trade deficit, increases income inequality, and exposes economy to external
shocks.

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Impact on Home Country (Originating Investment)

• Benefits: Increases profits and returns, access to cheaper resources and natural resources,
opens new markets for growth, expands production (economies of scale), and improves
efficiency through competitive pressure.

• Costs/Drawbacks: Job losses at home, political and operational risks, and reduced tax
revenues.

4. FDI in India & Government Measures

FDI is a vital non-debt financial force behind India's economic upsurge. To ensure an
uninterrupted influx, the Indian government has created a transparent, predictable policy
framework and eased restrictions on sectors like stock exchanges, defense, and telecom.

• Policy Measures: FDI allowed through Joint Ventures, 100% Export Oriented Units (EOUs),
and foreign technology agreements. Encouraged in most activities under the automatic
route. FIPB (Foreign Investment Promotion Board) approves proposals within 4-6 weeks.

• Sector Examples (2015-16 data): 100% FDI allowed in the health sector and construction/
real estate. Massive FDI ($14.65 billion) allowed into railway infrastructure.

• Benefits Realized: Consumers save 5-10% due to cheaper, better-quality products. Estimated
creation of 4-6 million jobs (especially in logistics), benefiting the national treasury by $25-30
billion.

PREVIOUS YEAR QUESTION / CONCEPT CHECK

Qus Policy Framework for FPI .

5. Policy Framework for FPI in India

The FPI regulations (2014) introduced by SEBI eased entry norms for foreign portfolio investors.
FIIs, sub-accounts, and Qualified Foreign Investors (QFIs) were merged into a single category:
FPIs. Over 1000 new FPIs registered recently.

• Highlights of SEBI Norms: Risk-based categorization, erased/minimalistic documentation

requirements, reduced registration fees, simplified KYC norms, speedier registration via
Designed Depositary Participants (DDPs), and enhanced investment limits.

• Regulatory Bodies:
◦ Ministry of Finance (MOF): Premier policy maker for taxation and capital markets.
Clarifies tax norms and limits.

◦ SEBI: Principal regulator for capital markets. FPIs must register with SEBI.

◦ RBI: Implements monetary policy, regulates foreign exchange markets through FEMA.

◦ Income Tax Dept (CBDT): Administers direct taxation and enforces Double Taxation
Avoidance Agreements.

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 Module 3: Contemporary Issues in Global Business

PREVIOUS YEAR QUESTION / CONCEPT CHECK

Qus Sustainable development + importance .

1. Sustainable Development

Means fulfilling the needs of the present generation without compromising the ability of future
generations to meet their own needs. It focuses on the balance between economic growth,
environmental protection, and social well-being.

• Importance:
◦ Environmental Protection: Clean access to water, air, etc.

◦ Future Security: Efficient resource use ensures longevity.

◦ Corporate Social Responsibility (CSR): Encourages business to act responsibly towards

the environment and society.

◦ Social Development: Reducing poverty, promoting equality.

PREVIOUS YEAR QUESTION / CONCEPT CHECK

Qus Cross borders mergers and acquisitions + Merits & Demerits .

2. Cross-Border Mergers & Acquisitions

A merger of two companies located in two different countries resulting in a third company (e.g.,
an Indian company merging with a foreign company). It transfers control and authority,
combining assets and liabilities.

• Benefits (Merits): Expansion of markets, geographic/industrial diversification, technology

transfer, avoiding entry barriers, tax planning/benefits, foreign exchange earnings,
utilization of material/labor at lower costs, and increased competitive advantage.

• Challenges (Demerits): Legal issues in different countries, accounting and taxation

challenges, technological differences, and political landscape/strategic issues.

PREVIOUS YEAR QUESTION / CONCEPT CHECK

Qus Strategic Alliances + Adv. & Disadvantages .

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3. Strategic Alliances

An agreement between two companies to share resources for mutually beneficial projects while
maintaining autonomy. Driven by the "3Cs": Combine resources, Capabilities, and Core
competencies.

• Advantages: Access to partner's resources/markets, lowers manufacturing costs, diffuses

new technologies, speeds up product introduction, overcomes trade barriers, economies of
scale, and leverages brand image.

• Disadvantages: Sharing of critical business secrets, partner can become a future competitor,
unequal decision-making power, control/coordination difficulties, clash of organizational
culture, limits flexibility, and risks to goodwill/reputation.

PREVIOUS YEAR QUESTION / CONCEPT CHECK

Qus Outsourcing ? Types + Importance + Issues .

4. Outsourcing (BPO)

Engaging the services of an external service provider (vendor) to manage and deliver non-core
business activities. Based on the concept of "Core Competency" (identify core strengths and
focus on them, outsource the rest).

• Types: Financial services, Advertising services, Courier services, Customer support services.

• Importance/Advantages: Concentration on core areas (specialization), better accountability

(quality ensured for fee), reduction in cost, fewer labor problems, avoiding fixed
investments, advantage of vendor consultancy, and overall economic progress.

• Issues: Data security risks, budget planning, time zone differences, maintaining skills and
quality, customer perception, unmet expectations, and allocation of decision rights and
authority.

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 UNIT 5 CONCEPT MAP: CORE PILLARS

Forex Market → Exchange Rates (Fixed/Float) → Spot vs. Forward →

Risk vs. Exposure

Foreign Investment → FDI vs. FPI → Greenfield vs. Brownfield →

Host / Home Impacts

Contemporary Issues → M&A / Strategic Alliances → Outsourcing (BPO) →

Sustainable Development

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