Global Financial System (BFIB233)

Unit I Environment of Global Financial System 6 Hours

Introduction – Global Financial System vs Domestic Financial System, Rise of
Multinational Corporation- Internationalization of Business and Finance-
Participants - Technological Advances and Other Developments

Unit II The Economic Environment 10 Hours

Introduction - Factors Determining Economic Activity- The Economic Cycle and
Economic Policy - Balance of Payments (BoP) and Exchange Rates Country Risk
Analysis Measuring Political
Risk- economic and political factors underlying country risk-Key Indicators of
Country Risk and Economic Health-Country Risk Analysis in International lending

Unit III Global Financial Securities- I 8 Hours

Equities/Stocks- Company Formation and Features and Benefits of Shares- The
Risks of Owning Shares- Corporate Actions- Bonds – Introduction- Characteristics
of Bonds- Types of Bonds- Asset-Backed Securities (ABSs)- International Bonds-
Yields- Other Financial Assets- Cash Deposit
Unit IV Global Financial Securities -II 8 Hours
Investment Funds-: Open-Ended Funds, Closed-Ended Investment Companies,
Exchange-Traded Funds (ETFs), Alternative Investment Funds (AIFs)- Derivatives

Unit V Global Financial Markets 10 Hours

Primary and Secondary Markets- Depositary Receipts- World Stock Markets-
Stock Market Indices- Settlement Systems. Money Markets- Property- Foreign
Exchange (FX)

Unit VI Global Financial Services 10 Hours

Financial Advice- Budgeting- Borrowing- Protection- Critical Illness Insurance
Cover- Investment and Saving- Legal Concepts in Financial Advice- The Financial
Advice Process- Other Financial Service: Wealth Management- Portfolio
Management- Brokerage Services-Credit Rating- Investment Banking- Factoring-
Depositories
Unit VII Regulation and Ethics 8 Hours
Need- Regulatory Principles- Financial Crime- Insider Trading and Market
Abuse- Integrity and Ethics in Professional Practice

Essential Reading:
• Shapiro Alan. C.(2012), Multinational Financial Management(9ed), Prentice
Hall, New Delhi.

Recommended Reading
1. Apte P.G (2011) , International Financial Management(6 ed), Tata McGraw
Hill, New Delhi.
2. Jeevanandam. C. Foreign Exchange and Risk Management. New Delhi: Sultan
Chand & sons.
3. Vij, M (2010). International Financial Management (3 ed). New Delhi: Excel
Books
 The Economic Environment
Economic systems are the means by which countries
determine how they will use these resources to resolve the
basic problem of what, how much, how, and for whom, to
produce. The main types of economic systems are a planned
economy, a market economy and a mixed economy, while an
open economy refers to a country’s economic relationship with
the rest of the world.
 Factors Determining Economic
Activity
• State-Controlled Economies
• Market Economies
• Mixed Economies
• Open Economies
 State-Controlled Economies
• A state-controlled economy is one in which the state (in the
form of the government) decides what is produced and how
it is distributed; they are also known as planned economies
or command economies.
• Sometimes, these economies are referred to as ‘planned
economies’, because the production and allocation of
resources is planned in advance rather than being allowed
to respond to market forces.
• The advantage of a planned economy is suggested to be low
levels of inequality and unemployment, with the common
good replacing profit as the primary incentive of production.
 Market Economies
• In a market economy, the forces of supply and demand
determine how resources are allocated.
• Businesses produce goods and services to meet the demand
from consumers.
• If there is oversupply, the price will be low and some
producers will leave the market. If there is undersupply, the
price will be high, attracting new producers into the market.
• There is a market not only for goods and services, but also for
productive assets, such as capital goods (eg, machinery),
labour and money.
• People compete for jobs and companies compete for
customers in a market economy.
 Mixed Economies
• A mixed economy combines a market economy with some element of
state control. The vast majority of established markets operate as mixed
economies to a lesser or greater extent.
• In a mixed economy, the government will provide a welfare system to
support the unemployed, the infirm and the elderly, in tandem with the
market-driven aspects of the economy. Governments will also spend
money running key areas such as defence, education, public transport,
health and police services.
• Governments raise finance for this public expenditure by:
1. collecting taxes directly from wage-earners and companies
2. collecting indirect taxes (eg, sales tax and taxes on petrol, cigarettes
and alcohol), and
3. raising money through borrowing in the capital markets.
 Open Economies
• In an open economy, there are few barriers to trade or
controls over foreign exchange.
• The World Trade Organization (WTO) exists to promote the
growth of free trade between economies. It is, therefore,
sometimes called upon to arbitrate when disputes arise. In
addition to global agreements on trade under the WTO, there
are many regional and bilateral trade agreements that go
beyond commitments made in the WTO that aim to increase
trade and boost economic growth.
 The Economic Cycle and Economic
Policy
• The role of government has been to manage the economy
through taxation, economic and monetary policy, and to ensure
a fair society by the state provision of welfare and benefits to
those who meet certain criteria.
• Governments can use a variety of policies when attempting to
reduce the impact of fluctuations in economic activity.
Collectively, these measures are known as stabilisation
policies and are categorised under the broad headings of fiscal
and monetary policy.
Macroeconomic Objectives
Macroeconomic policy is the management of the
economy by government in such a way as to influence
the performance and behaviour of the economy as a
whole. The main objectives are as follows:
• Simultaneous achievement of all four objectives is
extremely difficult. For example, the balance of
payments tends to deteriorate as economic growth
improves. This is because when growth is triggered
by an increase in aggregate demand, it often leads to
an increase in imports as foreign goods are bought by
UK manufacturers and consumers.
Stages of the Economic Cycle
• Peak – GDP is at its highest point. Any growth in output
stops. This is the point at which GDP is expected to decline,
eg, contraction of the economy is expected.
• Contraction – thus, is the period over which GDP declines as
economic activity slows. When there are two consecutive
quarters of declining GDP or ‘negative growth’, economists
refer to this as a ‘recession’.
• Trough – GDP is now at its lowest point. The contraction
phase is over.
• Expansion – economic activity picks up and GDP begins
growing once again. Early expansion is usually characterised
by a moderate increase in GDP, whereas with late expansion,
the rate of increase is higher.
 Fiscal Policy
Fiscal policy is any action by the government to spend
money, or to collect money in taxes, with the purpose of
influencing the condition of the economy. The government
will use the following tools to influence the level of spending
in the economy:
1. Budget
2. Taxation

Implications of Fiscal Policy for Business;

1. Planning
2. cost
 Monetary Policy
• Monetary policy is the regulation of the economy through
control of the monetary system by operating on such
variables as the money supply, the level of interest rates and
the conditions for the availability of credit. Monetary policy is
generally concerned with the volume of money in
circulation and the price of money or the interest rate.
• The Money Supply
The stock of money in the economy is believed to influence
the volume of expenditure in the economy. This, in turn,
influences the level of output and prices. Under monetary
policy, the government can target the stock of money as an
economic tool.
Interest Rates
• Interest represents the price of money or the cost of borrowing. It is,
therefore, assumed that there is a direct relationship between the interest
rate and the level of spending in the economy. An increase in interest
rates is thought to discourage spending in the economy and thereby reduce
the level of aggregate spending. Other possible outcomes include the
following:
• Consumers would be encouraged to save with higher interest rates.
• Mortgage payments would rise, leaving less disposable income for
homeowners.
• The higher cost of credit would deter borrowing and, hence,
spending.
• The level of corporate investments would decline due to higher
borrowing costs.
• The corporate sector may lose confidence in the economy and
become pessimistic about future prospects.
 Balance of Payments (BoP) and
Exchange Rates
• The balance of payments (BoP) is a summary of all the
transactions between a country and the rest of the world. If
the country imports more than it exports, there is a balance of
payments deficit. If the country exports more than it imports,
there is a balance of payments surplus.
• The main components of the balance of payments are the trade
balance, the current account and the capital account.
• ‘Right’ exchange rate is critical to the level of international
trade undertaken, to international competitiveness and,
therefore, to a country’s economic position.
• If the value of its currency rises, then exports will be less
competitive, unless producers reduce their prices, and imports
will be cheaper and, therefore, more competitive. The result
will be either to reduce a trade surplus or worsen a trade
deficit.
• If its value falls against other currencies, then the reverse
happens: exports will be cheaper in foreign markets and so
more competitive, and imports will be more expensive and
therefore less competitive. A trade surplus or deficit will
therefore see an improving position.
 Review Question
• Demonstrate the link between economic and
financial system in global environment
 Exchange Rates
• An exchange rate can be described as the price of one
currency in terms of another and is quoted for pairs of
currencies. If the exchange rate changes, such that currency A
can buy more of currency B, this shows an appreciation of
currency A and a depreciation of currency B.
For example, in the diagram below, we can see the exchange
moves such that USD 1 (formerly, equivalent to EUR 0.75) is
now equivalent to EUR 0.95. This appreciation of the USD
against the EUR has been caused by an increase in demand for
the USD.
 A significant factor that influences the volatility of exchange
rates is the exchange rate regime that the central bank
follows. These vary widely, but two extremes are described
below:
1. Fixed rate system – the exchange rate is pegged to a
particular currency, eg, the US dollar or a basket of
currencies. To ensure that the rate stays ‘fixed’, the central
bank will intervene in the currency market to offset the
natural forces of demand and supply by spending its foreign
currency reserves or buying foreign currency.
2. Floating rate system – the exchange rate is determined by
the natural forces of demand and supply. There is no
intervention in the market by the central bank. This is,
sometimes, referred to as a ‘free’ floating rate system.
 Examples of exchange rate regimes that fall within the two
extremes include the following:
• Target zone – similar to the fixed rate system, however, the
exchange rate is managed within a band (with upper and lower
limits). This means that the rate can fluctuate, therefore, the
central bank will only intervene if the upper or lower limits
for the rate are breached.
• Crawling peg – similar to target zone, but with upper and lower
limit bands gradually widening. This system is generally used
as a strategy for moving away from a fixed rate system.
• Managed float – this is also known as a ‘dirty’ float. With this
system, the exchange rate is largely a floating rate, but with
occasional intervention from the central bank to alter the
direction of the rate or the speed with which the rate
changes.
 Country risk
• Country risk refers to the risk of investing in a country, dependent on
changes in the business environment that may adversely affect operating
profits or the value of assets in a specific country.
• Thus country risk analysis consists of the assessment of political,
economic, and financial factors of a ‘borrowing country’ or an FDI host
country which may interrupt timely repayment of principal and interest or
may adversely affect returns on foreign investment.
 Different types of country risk

• Political risk
• Sovereign risk
• Neighbourhood risk
• Subjective risk
• Economic risk
• Exchange risk
• Transfer risk
 Political risk

• Political risk determines a country's political stability, either

internally or externally. For instance, a recent military coup would
increase a nation's internal political risk for businesses as rules and
regulations suddenly shift. Other risks in this category could include
war, terrorism, corruption and excessive bureaucracy (i.e. host
government red tape is preventing certain fund transfers or other
transactions).
• Political risk can affect a country's attitude to meeting its debt
obligations and may cause sudden changes in the foreign exchange
market.
 Sovereign risk

• There is some crossover between political and sovereign risk, although

the latter – also known as sovereign default risk – primarily examines
debt. Specifically, this risk category measures the build up of debt
that is the obligation of a government or its agencies (or that is
guaranteed by the government), and how much said government is
anticipated to fulfill these obligations.
• For example, if a government agency refuses to carry out debt
refunding, this could impact local lenders and lead to losses. This would
of course have roll-on effects to local businesses and anyone
undertaking trade with them.
 Neighbourhood risk

• Neighbourhood risk, also known as location risk, may not be

the direct fault of the country with which your clients are
dealing, but instead is caused by trouble elsewhere. This can
have spillover effects on other sovereign nations, creating
turmoil in the foreign market or putting pressure on local lenders
and businesses.
• Neighbourhood risk can be caused by:
1. Geographic neighbours.
2. Trading partners.
3. Co-members of certain institutions or organisations.
4. Strategic allies.
5. Nations with similar perceived characteristics.
 Subjective risk

• Subjective risk is not a term that is used everywhere, but it

measures factors that are common to most risk
assessments – and could greatly impact foreign business
owners trading with a host nation. Subjective risk is about
attitudes, and can include social pressures and consumer
opinions – whether to certain types of goods or certain types
of enterprise.
 Economic risk
• Economic risk encompasses a wide range of potential issues
that could lead a country to renege on its external debts or
that may cause other types of currency crisis (i.e.
recession). A major factor here is economic growth – the
health of a nation's GDP and the outlook for its future. For
instance, if a country relies on a few key exports and the
prices for these are dropping, this creates a negative outlook
and may increase the economic risk for foreign trading
partners.
• Acts of government may also impact economic risk, such as
intervention in the money market or policy changes that
cause tax instability. One other factor is issues with foreign
currency exchange, for instance a shortage in certain
currencies or a devaluation of the exchange rate.
 Exchange risk
• Any predicted loss created by sudden changes in exchange
rate are generally covered under the exchange risk factor. This
is another all-encompassing term as fluctuations in the foreign
exchange can be caused by a wide variety of factors.
Economic and political factors such as those mentioned
above can be significant drivers of exchange risk, although
currency reserves, interest rates and inflation are also potential
factors.
• One example of political change that can harm economic risk
is a change in currency regime, for example from fixed regime
to floating.
 Transfer risk
• This is where the host government becomes unwilling or unable
to permit foreign currency transfers out of the nation. Sweeping
controls such as these may be a side effect of a nation in crisis
attempting to prevent creditor panic turning into significant capital
outflow. A major example of this occurring is the Malaysia credit
controls after the 1997-98 Asian currency crisis.
• Regardless of cause, capital control can prevent foreign traders from
retrieving profits or dividends from the host country.
Types of Risk in International Business

• Economic Risk
• Political Risk
• Structural Assessment
• Debt Management
 Economic Risk in International Trade
Businesses can analyze economic data by country using the
following key economic indicators. These indicators provide
a snapshot of a country’s economic performance and future
prospects that can help paint a fuller picture when evaluating
country risk.
• The stability and solvency of banks
• The short-, medium- and long-term outlook for country’s
GDP and GNP
• Debt-to-GDP ratio
• Unemployment rate
• Overall government finances
• Monetary policy and currency stability
• Currency exchange rates
• Access to affordable capital
 Political Risk

Here are some examples of factors you should consider when

conducting an evaluation of political risk:
• Government stability
• Information access and transparency
• Terrorism, violence and crime
• Regulatory and policy environment
• Workforce freedom and mobility
• Government assistance programs for businesses
• Immigration and employment laws
• Attitudes toward foreign investment
 Structural Assessment

• The structural factors within a specific country also merit close

inspection. Structural factors include any fixed elements within the
country that can impact economic performance, including:
• Demographics
• Physical infrastructure
• Social infrastructure
• Labor force
• Competitors
• Treaty participation
• Export regulations
• Import acceptance from other countries
• Co-production opportunities with other nations
 Debt Management
Debt management should be an important consideration in your
country risk analysis. Debt management deals with how well a
country is managing its debt load and whether it is growing,
static or declining. High levels of government debt can lead to
inflation and currency destabilization, both of which are likely
to have a real and significant impact on any company doing
business in and with that country.
• Total debt stocks to GNP
• Debt service to exports
• Current account balance to GNP