The important distinguishing features of international finance from domestic financial management are discussed below:
Foreign exchange risk
An understanding of foreign exchange risk is essential for managers and investors in the modern day environment of unforeseen changes in foreign exchange rates. In a domestic economy this risk is generally ignored because a single national currency serves as the main medium of exchange within a country. When different national currencies are exchanged for each other, there is a definite risk of volatility in foreign exchange rates. The present International Monetary System set up is characterized by a mix of floating and managed exchange rate policies adopted by each nation keeping in view its interests. In fact, this variability of exchange rates is widely regarded as the most serious international financial problem facing corporate managers and policy makers.
At present, the exchange rates among some major currencies such as the US dollar, British pound, Japanese yen and the euro fluctuate in a totally unpredictable manner. Exchange rates have fluctuated since the 1970s after the fixed exchange rates were abandoned. Exchange rate variation affect the profitability of firms and all firms must understand foreign exchange risks in order to anticipate increased competition from imports or to value increased opportunities for exports.
Thus, changes in the exchange rates of foreign currencies results in foreign exchange risks.
Another risk that firms may encounter in international finance is political risk. Political risk ranges from the risk of loss (or gain) from unforeseen government actions or other events of a political character such as acts of terrorism to outright expropriation of assets held by foreigners. The other country may seize assets of the company without any reimbursements by utilizing their sovereign right, and some countries may restrict currency remittances to the parent company. MNCs must assess the political risk not only in countries where it is currently doing business but also where it expects to establish subsidiaries. The extreme form of political risk is when the sovereign country changes the ‗rules of the game‘ and the affected parties have no alternatives open to them.
Example: In 1992, Enron Development Corporation, a subsidiary of a Houston based Energy Company, signed a contract to build India‘s longest power plant. Unfortunately, the project got cancelled in 1995 by the politicians in Maharashtra who argued that India did not require the power plant. The company had spent nearly $ 300 million on the project. The Enron episode highlights the problems involved in enforcing contracts in foreign countries.
Thus, political risk associated with international operations is generally greater than that associated with domestic operations and is generally more complicated.
Expanded opportunity sets
When firms go global, they also tend to benefit from expanded opportunities which are available now. They can raise funds in capital markets where cost of capital is the lowest. In addition, firms can also gain from greater economies of scale when they operate on a global basis.
The final feature of international finance that distinguishes it from domestic finance is that world markets today are highly imperfect. There are profound differences among nations‘ laws, tax systems, business practices and general cultural environments. Imperfections in the world financial markets tend to restrict the extent to which investors can diversify their portfolio. Though there are risks and costs in dealing with these market imperfections, they also offer managers of international firms abundant opportunities.
Tax and Legal system
Tax and legal system varies from one country to another country and this leads to complexity in their financial implications and hence give rise to tax and legal risks.
Inflation rate differs from country to country. Higher inflation rates in few countries denote inflation risks.
Major turmoil influencing International financial Market
Frictions on International financial market can be in the form of .
With the help of different controlling procedures, government tries to control international financial flows like maintaining the multiple exchange rates, taxes on international flows and constructs on outflow of funds. These slower the pace of international/foreign investment flows .
Different tax laws
Capital gains, interest income, dividend and other financial transactions reduce the post tax returns and thus restrict the scope of international portfolio investment.
Implicit and explicit transaction costs
Trading fees/commission, bid ark speared is a form of Implicit and explicit transaction which affects the International financial market. The transactions costs is less in developed countries compared to newly market economies/countries. Transactions costs per unit decreases when the size of transaction is large. However, small investors are not benefited from this strategy.