1.

Discuss the transaction exposures faced by an MNC

Transaction exposure refers to the risk an MNC (Multinational Corporation)

faces due to fluctuations in exchange rates between the time a
transaction is initiated and when it is settled. This is one of the most direct
forms of foreign exchange risk. For instance, if an MNC based in the U.S.
sells goods to a European company and receives payment in euros after
90 days, any depreciation of the euro against the dollar during this period
will reduce the dollar value of the payment received, resulting in a
financial loss.

MNCs often deal with multiple currencies across countries, leading to

frequent exposure in export/import transactions, repatriation of profits,
and servicing of foreign debt. Transaction exposure can affect both
revenues and costs. For example, if a subsidiary is expected to pay $1
million to its parent company, and the local currency depreciates before
payment, the parent receives less value. Similarly, costs may rise if
payments for imports or raw materials need to be made in a stronger
foreign currency.

To manage transaction exposure, MNCs use financial instruments like

forward contracts, futures, options, and currency swaps. Additionally,
natural hedging, like matching currency inflows and outflows, can reduce
the need for external hedging. Effective management of transaction
exposure is crucial to maintaining profit margins and ensuring financial
stability in volatile currency environments.

2. Explain the Purchasing Power Parity Theory and

Interest Rate Parity Theory

Purchasing Power Parity (PPP) Theory suggests that in the long run,
exchange rates between currencies should adjust so that a basket of
goods costs the same in each country when priced in a common currency.
There are two versions: Absolute PPP (direct price comparisons) and
Relative PPP, which states that the rate of change in exchange rates over
time will equal the difference in inflation rates between two countries. For
example, if inflation in India is 6% and in the U.S. it is 2%, the rupee
should depreciate against the dollar by 4% over time.

Interest Rate Parity (IRP) Theory asserts that the difference in interest
rates between two countries is equal to the difference between the
forward exchange rate and the spot exchange rate. It ensures that there
is no arbitrage opportunity from borrowing in one currency and investing
in another. Under Covered Interest Rate Parity, the forward premium or
discount offsets the interest rate differential. Uncovered IRP assumes that
future spot rates adjust to compensate for interest differentials.

Both PPP and IRP play key roles in international financial management by
helping firms forecast exchange rates and manage risks. However, they
are theoretical models and may not hold in the short term due to market
imperfections, capital controls, and transaction costs.

3. What is an accounting exposure? What is its

significance and how do we manage this exposure?

Accounting exposure, also called translation exposure, arises when a firm

translates the financial statements of its foreign subsidiaries into the
home currency for consolidated reporting. This exposure reflects the
impact of currency fluctuations on the reported earnings, assets, and
liabilities, even though no actual cash flow is involved. For instance, a
U.S.-based MNC with a subsidiary in Japan may see changes in the dollar
value of the subsidiary's assets and earnings as the yen fluctuates.

The significance of accounting exposure lies in how it can distort the

financial performance of a company. Investors and analysts closely
monitor earnings; thus, significant translation losses (even if unrealized)
may affect stock price or management decisions. It also impacts the
evaluation of managerial performance across subsidiaries.

To manage accounting exposure, companies can adopt one of several

translation methods—current rate, temporal, or monetary/non-monetary
methods. Some firms use balance sheet hedges (matching assets and
liabilities in the same currency) or forward contracts to offset possible
valuation changes. However, since accounting exposure does not involve
real cash flows, many firms consider it less critical than transaction
exposure, though still important for transparent financial reporting.

4. Discuss the nature and scope of International Financial

Management by a MNC

International Financial Management (IFM) deals with financial decisions in

an international context. It encompasses investment, financing, risk
management, and operational decisions for multinational corporations
operating across multiple countries. The nature of IFM is complex due to
currency fluctuations, varying regulatory environments, diverse tax
regimes, and political risks.

The scope of IFM includes:

 Capital budgeting for cross-border projects, accounting for

differing cost of capital and currency risks.
 Working capital management, including managing receivables
and payables in multiple currencies.
 Financing decisions, such as raising funds in foreign markets,
eurocurrency markets, or through instruments like ADRs and GDRs.
 Foreign exchange risk management (transaction, translation,
and economic exposure).
 Taxation and repatriation planning, to optimize the global tax
burden and ensure efficient profit flows.
  Political and country risk analysis, crucial for investing in
emerging markets.

Overall, IFM aims to enhance shareholder value by optimizing financial

performance across borders. A successful MNC must integrate financial
strategy with global market dynamics while maintaining compliance with
local laws and mitigating currency and political risks.

5. Define balance of payment? Why would it be useful to

examine a country’s balance of payment? What are the
limitations of Balance of Payment Statement? Show a
typical balance of payment

The Balance of Payment (BoP) is a systematic record of all economic

transactions between a country and the rest of the world over a given
period. It includes trade in goods and services, cross-border investment
flows, and financial transfers. It is divided into three main components:

1. Current Account: Exports and imports of goods/services, income

receipts and payments, and current transfers.
2. Capital Account: Transfers of capital assets, debt forgiveness.
3. Financial Account: Foreign investments, portfolio investments,
and changes in reserves.

Usefulness:

 Indicates a country's economic health and international

competitiveness.
 Helps governments frame monetary and fiscal policies.
 Useful to investors and credit rating agencies assessing country risk.
 Reveals trends in foreign exchange reserves and dependence on
foreign capital.
Limitations:

 Time lags in data reporting.

 Errors and omissions may affect accuracy.
 Non-market transactions may be excluded.
 Doesn’t reflect underground or informal economy activities.

Jaga Chora

6. Differentiate between currency future contracts and options

contracts

Basis of Currency Futures

Currency Options Contracts
Comparison Contracts
A standardized agreement
A contract giving the right (not
Definition to buy/sell currency at a
obligation) to buy/sell currency
future date
Both buyer and seller are Buyer has the right; seller has
Obligation obligated to execute the the obligation if the option is
contract exercised
Cost No upfront cost (except
Buyer pays a premium upfront
Involved margin requirements)
Buyer: limited loss (premium),
Profit/Loss
Unlimited for both parties unlimited gainSeller: limited
Potential
gain, potential loss
Trading Traded on exchanges (e.g., Traded on exchanges and
Venue CME) over-the-counter (OTC)
Can be standardized
Standardizati Highly standardized
(exchange) or customized
on (contract size, expiry, etc.)
(OTC)
Daily mark-to-market
Premium paid upfront; settled
Settlement (cash settled or delivery on
if exercised
maturity)
Risk Suitable for hedging with
Suitable for hedging fixed
Management flexibility (in case of
currency exposures
Use uncertainty)
Leverage Requires margin deposits No margin required for buyer;
and Margin and maintenance margins seller may need margin
Market View Suitable when future Suitable when there's
 Basis of Currency Futures
Currency Options Contracts
Comparison Contracts
currency rate movement is uncertainty about future rate
certain direction

7. Explain the different stages in the International

Monetary System

The International Monetary System (IMS) refers to the framework of

institutions and rules that govern international financial flows and
exchange rate mechanisms. The evolution of the IMS has occurred in
several stages:

1. Gold Standard (1870s–1914): Currencies were backed by gold

reserves. Exchange rates were fixed based on gold parity. Provided
stability but lacked flexibility during economic crises.
2. Interwar Period (1918–1944): Breakdown of the gold standard
after WWI led to currency instability, competitive devaluations, and
economic turmoil. No coordinated international system existed.
3. Bretton Woods System (1944–1971): Established after WWII,
where currencies were pegged to the US dollar, which was
convertible to gold. Institutions like the IMF and World Bank were
founded. This system provided stability but eventually collapsed due
to persistent U.S. deficits and inability to maintain gold
convertibility.
4. Post-Bretton Woods / Managed Float (1971–Present):
Currencies are now mostly on floating or managed float systems.
The U.S. ended dollar convertibility to gold. Exchange rates are
determined by market forces, though central banks occasionally
intervene.
5. European Monetary Union (1999–Present): The euro was
introduced, creating a unified monetary system for member
countries with a common currency and central bank (ECB).
6. Present Day – Hybrid System: The global monetary system today
consists of floating, pegged, and dollarized currencies. Financial
globalization, digital currencies, and challenges like global
imbalances and capital flows have created a more complex system.

Each stage reflects evolving needs for international trade, economic

stability, and the balance between national sovereignty and global
cooperation.