Lesson Seven: Foreign Investment Management

- Foreign direct investment,

international capital budgeting, international capital structure and cost of capital. International
portfolio management. International financing: Equity, Bond financing, parallel loans,
international cash management, accounts receivable management, inventory management.

Foreign Direct Investment

A foreign direct investment (FDI) is an investment made by a firm or individual in one
country into business interests located in another country. Generally, FDI takes place when
an investor establishes foreign business operations or acquires foreign business assets in a
foreign company. However, FDIs are distinguished from portfolio investments in which an
investor merely purchases equities of foreign-based companies.
Foreign direct investments are commonly made in open economies that offer a skilled
workforce and above-average growth prospects for the investor, as opposed to tightly
regulated economies. Foreign direct investment frequently involves more than just a capital
investment. It may include provisions of management or technology as well. The key feature
of foreign direct investment is that it establishes either effective control of or at least
substantial influence over the decision-making of a foreign business.

Types of Foreign Direct Investment

1. FDI: It is the investment done by a company or organization which practices all the tasks
and activities done at the investing company, back at its own country of operation.
Therefore, basically such investors are from the same industry where investments are
done but operating in two different countries. For e.g., a car manufacture in Australia
invests in a car manufacturing company of Kenya.
2. Vertical FDI: The industry of the investor and the company where investments are done
are related to each other. This type of FDI is further classified as:
a) Forward Vertical FDI: In such investments, foreign investments are done in
organizations which can take the products forward towards the customers. For e.g., a
car manufacturing company in Australia invests in a wholesale Car Dealer company
in Kenya.
 b) Backward Vertical FDI: In such investments, foreign investments are done in an
organization which is involved in sourcing of products for the particular industry. For
e.g., the car manufacturer of Australia invests in a tyre manufacturing plant in Kenya.
c) Conglomerate FDI: Such investments are done to gain control in unrelated business
segments and industries in a foreign land. For e.g., the car manufacturer of Australia
invests in a consumer durable good manufacturer in Kenya. Here the investing
company ideally manages two challenges, first being gaining operational control in a
foreign land, and the second being starting operations in a new industry segment.
d) Greenfield Entry: In this special type of FDI, the investing company refers to an
investing organization starting assembling from scratch just like Honda did in United
Kingdom
e) Foreign Takeover: This type of FDI takes the form of a foreign merger

Theories Of FDI
a)Mac Dougall -Kemp Hypothesis
FDI moves from capital abundant economy to capital scarce economy till the marginal
production is equal in both countries. This leads to improvement in efficiency in utilization of
resources in which leads to ultimate increase in welfare. According to this theory, foreign
direct investment is a result of differences in capital abundance between economies. This
theory was developed by MacDougal (1958) and was later elaborated by Kemp (1964)
b) Industrial Organization Theory
According to this theory, MNC with superior technology moves to different countries to
supply innovated products making in turn ample gains. Krugman (1989) points out that it was
technological advantage possessed by European countries which led to massive investment in
USA .According to this theory, technological superiority is the main driving force for foreign
direct investment rather that capital abundance.
c)Currency Based Approaches
A firm moves from strong currency country to weak currency country. Aliber (1971)
postulates that firms from strong currency countries move out to weak currency countries.
Froot and Stain (1989) holds that, depreciation in real value of currency of a country lowers
the wealth of a domestic residents visa avis the wealth of the foreign residents, thus being
cheaper for foreign firms to acquire assets in such countries. Therefore, foreign direct
investments will move from countries with strong currencies to those with weak or
depreciating currencies.
d) Location-Specific Theory
Hood and Young (1979) stress on the location factor. According to them, FDI moves to a
countries with abundant raw materials and cheap labor force. Since real wage cost varies
among countries, firms with low-cost technology move to low wage countries. Abundance of
raw materials and cheap labor force are the main factors for FDI. Countries with cheap labor
and abundant raw material will tend to attract FDI.
e) Product Cycle Theory
FDI takes place only when the product in question achieves specific stage in its life cycle-
introduction, growth, maturity and decline stage. At maturity stage, the demand for new
product in developed countries grow substantially and rival firms begin to emerge producing
similar products at lower price. So in order to compete with rivals, innovators decide to set
up production in the host country so as to beat up the cost of transportation and tariffs.
f) Political-Economic Theories
They concentrate on the political risks. Political stability in the host country leads to
FDI(Fatehi-Sedah and Safizeha 1989).Similarly, political instability in the home country
encourages FDI in other countries(Tallman 1988).

Strategy for FDI

i) Firm-Specific Strategy
It means offering new kind of product or differentiated product. When product innovation
fails to work, a firm may adopt product differentiation strategy. This is done through putting
trade mark on the product or branding. Sometimes a firm may adopt different brands for
different markets to make them suitable for local markets. Bata for example, operates in 92
countries under the same trade mark, while Uniliver‘s low - leather fabric washing product is
marketed is market under five different brands in Western Europe.
ii) Cost-Economic Strategy
This strategy is done through lowering cost by moving the firm to the places where there are
cheap factors of production (eg. labour and raw materials).The cheapness of these factors of
production reduces the cost of production and maintains an edge over other firm
iii) Joint Venture with a Rival Firm
Sometimes when a rival firm in a host country is so powerful that it is not easy for MNC to
compete, the later prefer to join hands with the host country firm for a joint venture
agreement and the MNC is able to operate the host country market.
iv) Investment Mode Strategy
This strategy depends on the move of investment favored by the host country. It depends also
on the political and economic environment of the host country. If the host government does
not favor a particular mode, an investing company cannot adopt it even if it is the most
suitable.

Costs and Benefits Of FDI

A cost-benefit analysis is a process by which business decisions are analyzed. The benefits of
a given situation or business related action are summed, and then the costs associated with
taking that action are subtracted.
Prior to erecting a new plant or taking on a new project, prudent managers conduct a cost-
benefit analysis as a means of evaluating all the potential costs and revenues that may be
generated if the project is completed. The outcome of the analysis will determine whether the
project is financially feasible or if another project should be pursued.
Cost and benefits of FDI can be classified as two
• Cost and Benefits of the Host Country
• Cost and Benefits of the investing MNC
a) Benefits of Host Country
i) Improving the balance of payments
Inward investment will usually help a country's balance of payments situation. The
investment itself will be a direct flow of capital into the country and the investment is
also likely to result in import substitution and export promotion. Export promotion comes
due to the multinational using their production facility as a basis for exporting, while
import substitution means that products previously imported may now be bought
domestically.
ii) Providing employment
FDI will usually result in employment benefits for the host country as most employees
will be locally recruited. These benefits may be relatively greater given that governments
will usually try to attract firms to areas where there is relatively high unemployment or a
good labour supply
iii) Source of tax revenue
Profits of multinationals will be subject to local taxes in most cases, which will provide a
valuable source of revenue for the domestic government.
iv) Technology transfer
Multinationals will bring with them technology and production methods that are probably
new to the host country and a lot can therefore be learnt from these techniques. Workers will
be trained to use the new technology and production techniques and domestic firms will see
the benefits of the new technology.
This process is known as technology transfer
• Building of economic and social infrastructure.
• Strengthening of the government budget. Stimulation of national economy
• The presence of one multinational may improve the reputation of the host country
and other large corporations may follow suite and locate as well
b) Costs of the Host Country
• Cultural and political interference.
• Unhealthy competition to Domestic players
• Over utilization of local resources (both natural and human resources)
• Violation of human rights (child labor eg. the case of NIKE in Vietnam, APPLE
in China etc)
• Threat to indigenous technology.
• Threat to local products.
c) Benefits of Investing MNCs
• Access to markets
FDI can be an effective way for you to enter into a foreign market. Some countries may
extremely limit foreign company access to their domestic markets. Acquiring or starting a
business in the market is a means for you to gain access
• Access to resources
FDI is also an effective way for you to acquire important natural resources, such as precious
metals and fossil fuels. Oil companies, for example, often make tremendous FDIs to develop
oil fields.
• Reduces cost of production
FDI is a means for you to reduce your cost of production if the labor market is cheaper and
the regulations are less restrictive in the target foreign market. For example, it's a well-known
fact that the shoe and clothing industries have been able to drastically reduce their costs of
production by moving operations to developing countries.
• Its also likely that Investors may get investment incentives, promotion, social amenities.
d) Costs to Investing MNCs
• Risk from Political Changes. Because political issues in other countries can instantly
change, foreign direct. Investment is very risky. Plus, most of the risk factors that you are
going to experience are extremely high.
• Hindrance to Domestic Investment. As it focuses its resources elsewhere other than the
investor‘s home
Country, foreign direct investment can sometimes hinder domestic investment
• Economic Non-Viability. Considering that foreign direct investments may be capital-
intensive from the point of view of the investor, it can sometimes be very risky or
economically non-viable.
• measured in terms of cash flows. The estimation of the cash inflows and cash outflows
mainly depends on future uncertainties. The risk associated with each project must be
carefully analyzed and sufficient provision must be made for covering the different types of
risks. Expropriation. Remember that political changes can also lead to expropriation, which
is a scenario where the government will have control over your property and assets.
Investment abroad takes away employment opportunities of the people in the home country.
International capital budgeting
The process through which different projects are evaluated is known as capital budgeting.
Capital budgeting is defined ―as the firm‘s formal process for the acquisition and
investment of capital. It involves firm‘s decisions to invest its current funds for addition,
disposition, modification and replacement of fixed assets‖.
―Capital budgeting is long term planning for making and financing proposed capital outlays‖
―Capital budgeting consists in planning development of available capital for the purpose of
maximizing the long term profitability of the concern.The main features of capital budgeting
are
a. potentially large anticipated benefits
b. a relatively high degree of risk
c. relatively long time period between the initial outlay and the anticipated return.
Significance of capital budgeting
• The success and failure of business mainly depends on how the available resources
are being utilized.
• It‘s a main tool of financial management.
• All types of capital budgeting decisions are exposed to risk and uncertainty.
• They are irreversible in nature
• Capital rationing gives sufficient scope for the financial manager to evaluate different
proposals and only viable
• project must be taken up for investments.
• Capital budgeting offers effective control on cost of capital expenditure projects. It
helps the management to avoid
• over investment and under investments.
Capital budgeting process involves the following
i) Project generation: Generating the proposals for investment is the first step.
• The investment proposal may fall into one of the following categories:
• Proposals to add new product to the product line,
• proposals to expand production capacity in existing lines
 • proposals to reduce the costs of the output of the existing products without
altering the scale of operation.
No standard administrative procedure can be laid down for approving the investment
proposal. The screening and selection procedures are different from firm to firm

ii) Project Evaluation: It involves two steps Estimation of benefits and costs: the benefits
and costs are
Once the proposal for capital expenditure is finalized, it is the duty of the finance manager to
explore the different alternatives available for acquiring the funds. He has to prepare capital
budget. Sufficient care must be taken to reduce the average cost of funds. He has to prepare
periodical reports and must seek prior permission from the top management. Systematic
procedure should be developed to review the performance of projects during their lifetime
and after completion.
The follow up, comparison of actual performance with original estimates not only ensures
better forecasting but also helps in sharpening the techniques for improving future forecasts.
Selection of appropriate criteria to judge the desirability of the project: It must be
consistent with the firm‘s objective of maximizing its market value. The technique of time
value of money may come as a handy tool in evaluation such proposals.
Factors influencing capital budgeting
• Availability of funds
• Structure of capital
• Taxation policy
• Government policy
• Lending policies of financial institutions
• Immediate need of the project
• Earnings
• Capital return
• Economical value of the project
• Working capital
• Accounting practice
• Trend of earnings
Methods of capital budgeting
Traditional methods
• Payback period
• Accounting rate of return method
Discounted cash flow methods
• Net present value method
• Profitability index method
• Internal rate of return method (IRR)
Merits of IRR
‘It considers the time value of money. Calculation of cost of capital is not a prerequisite for
adopting IRR. IRR attempts to find the maximum rate of interest at which funds invested in
the project could be repaid out of the cash inflows arising from the project. It is not in
conflict with the concept of maximizing the welfare of the equity shareholders.
It considers cash inflows throughout the life of the
project.

Cons

• Computation of IRR is tedious and difficult to understand

• Both NPV and IRR assume that the cash inflows can be reinvested at the discounting rate
in the new projects. However, reinvestment of funds at the cut off rate is more
appropriate than at the IRR.
• IT may give results inconsistent with NPV method.
• This is especially true in case of mutually exclusive project
Step 1: Calculation of cash outflow
Cost of project/asset xxxx
Transportation/installation charges xxxx
Working capital xxxx Cash outflow xxxx
Step 2: Calculation of cash inflow
Sales xxxx
Less: Cash expenses xxxx
PBDT xxxx
 Less: Depreciation xxxx
PBT xxxx
Less: Tax xxxx
PAT xxxx
Add: Depreciation xxxx
Cash inflow p.a xxxx
International capital structure and cost of capital
The capital structure is the particular combination of debt and equity used by a company to
finance its overall operations and growth. Debt comes in the form of bond issues or loans,
while equity may come in the form of common stock, preferred stock, or retained earnings.
Short-term debt such as working capital requirements is also considered to be part of the
capital structure.
Many major firms throughout the world have begun to internationalize their capital structure
by raising funds from foreign as well as domestic sources. As a result, these corporations are
becoming multinational not only in the scope of their business activities but also in their
capital structure.
By internationalizing its corporate ownership structure, a firm can generally increase its share
price and lower its cost of capital. This trend reflects the ongoing liberalization and
deregulation of international financial markets that make them accessible for many firms.
Cost of capital is the required return necessary to make a capital budgeting project, such as
building a new factory, worthwhile. When analysts and investors discuss the cost of capital,
they typically mean the weighted average of a firm's cost of debt and cost of equity blended
together.
The cost of capital metric is used by companies internally to judge whether a capital project
is worth the expenditure of resources, and by investors who use it to determine whether an
investment is worth the risk compared to the return. The cost of capital depends on the mode
of financing used. It refers to the cost of equity if the business is financed solely through
equity, or to the cost of debt if it is financed solely through debt.
Many companies use a combination of debt and equity to finance their businesses and, for
such companies, the overall cost of capital is derived from the weighted average cost of all
capital sources, widely known as the weighted average cost of capital (WACC).
International Portfolio Management
An international portfolio is a grouping of investment assets that focuses on securities from
foreign markets rather than domestic ones. An international portfolio is designed to give the
investor exposure to growth in emerging and developed markets and provide diversification.
Diversification is a risk management strategy that mixes a wide variety of investments within
a portfolio. A diversified portfolio contains a mix of distinct asset types and investment
vehicles in an attempt at limiting exposure to any single asset or risk. The rationale behind
this technique is that a portfolio constructed of different kinds of assets will, on average,
yield higher long-term returns and lower the risk of any individual holding or security.
The art of selecting the right investment policy for the individuals in terms of minimum risk
and maximum return is called as portfolio management.
Portfolio management refers to managing an individual‘s investments in the form of bonds,
shares, cash, mutual funds etc so that he earns the maximum profits within the stipulated time
frame.
Portfolio management refers to managing money of an individual under the expert guidance
of portfolio managers.
In a layman‘s language, the art of managing an individual‘s investment is called as portfolio
management.
Need for Portfolio Management
• Portfolio management presents the best investment plan to the individuals as per their
income, budget, age and ability to undertake risks.
• Portfolio management minimizes the risks involved in investing and also increases the
chance of making profits.
• Portfolio managers understand the client’s financial needs and suggest the best and
unique investment policy for them with minimum risks involved.
• Portfolio management enables the portfolio managers to provide customized investment
solutions to clients as per their needs and requirements.
Types of Portfolio Management
Portfolio Management is further of the following types:
• Active Portfolio Management: As the name suggests, in an active portfolio management
service, the portfolio managers are actively involved in buying and selling of securities to
ensure maximum profits to individuals.
• Passive Portfolio Management: In a passive portfolio management, the portfolio manager
deals with a fixed portfolio designed to match the current market scenario.
• Discretionary Portfolio management services: In Discretionary portfolio management
services, an individual authorizes a portfolio manager to take care of his financial needs
on his behalf. The individual issues money to the portfolio manager who in turn takes
care of all his investment needs, paper work, documentation, filing and so on. In
discretionary portfolio management, the portfolio manager has full rights to take
decisions on his client‘s behalf.
• Non-Discretionary Portfolio management services: In non discretionary portfolio
management services, the portfolio manager can merely advise the client what is good
and bad for him but the client reserves full right to take his own decisions.
Modes of Global Portfolio Management
Foreign securities or depository receipts can be bought directly from a particular country‘s
stock exchange. Two concepts are important here which can be categorized as Portfolio
Equity and Portfolio Bonds. These are supposed to be the best modes of GPM. A brief
explanation is provided hereunder.
Portfolio Equity
Portfolio equity includes net inflows from equity securities other than those recorded as
direct investment and including shares, stocks, depository receipts (American or global), and
direct purchases of shares in local stock markets by foreign investors.
Portfolio Bonds
Bonds are normally medium to long-term investments. Investment in Portfolio Bond might
be appropriate if
One have additional funds to invest.
One seek income, growth potential, or a combination of the two.
 Global Mutual Funds
Global mutual funds can be a preferred mode if the Investor wants to buy the shares of an
internationally diversified mutual fund. In fact, it is helpful if there are open-ended mutual
funds available for investment.
Closed-end Country Funds

Closed-end funds invest in internationals securities against the portfolio. This is helpful
because the interest rates may be higher, making it more profitable to earn money in that
particular country. It is an indirect way of investing in a global economy. However, in such
investments, the investor does not have ample scope for reaping the benefits of
diversification, because the systematic risks are not reducible to that extent.
Drawbacks of Global Portfolio Management
Global Portfolio Management has its share of drawbacks too. The most important ones are
listed below.
• Unfavorable Exchange Rate Movement -Investors are unable to ignore the probability of
exchange rate changes in a foreign country. This is beyond the control of the investors.
These changes greatly influence the total value of foreign portfolio and the earnings from
the investment. The weakening of currency reduces the value of securities as well.
• Frictions in International Financial Market-There may be various kinds of market
frictions in a foreign economy. These frictions may result from Governmental control,
changing tax laws, and explicit or implicit transaction costs. The fact is governments
actively seek to administer international financial flows. To do this, they use different
forms of control mechanisms such as taxes on international flows of FDI and applied
restrictions on the outflow of funds.
• Manipulation of Security Prices-Government and powerful brokers can influence the
security prices. Governments can heavily influence the prices by modifying their
monetary and fiscal policies. Moreover, public sector institutions and banks swallow a
big share of securities traded on stock exchanges.
Unequal Access to Information -Wide cross-cultural differences may be a barrier to GPM. It
is difficult to disseminate and acquire the information by the international investors
beforehand
International financing:
a)Equity financing
Equity financing is the process of raising capital through the sale of shares. Companies raise
money because they might have a short-term need to pay bills or they might have a long-term
goal and require funds to invest in their growth. By selling shares, they sell ownership in
their company in return for cash, like stock financing.
Equity financing comes from many sources; for example, an entrepreneur's friends and
family, investors, or an initial public offering (IPO). Industry giants such as Google and
Facebook raised billions in capital through IPOs.
Equity risk is "the financial risk involved in holding equity in a particular investment".
Equity risk often refers to equity in companies through the purchase of stocks, and does not
commonly refer to the risk in paying into real estate or building equity in properties.
The measure of risk used in the equity markets is typically the standard deviation of a
security's price over a number of periods. The standard deviation will delineate the normal
fluctuations one can expect in that particular security above and below the mean, or average.
However, since most investors would not consider fluctuations above the average return as
"risk", some economists prefer other means of measuring it.
b) Bond financing
Bond financing is a type of long-term borrowing that state and local governments frequently
use to raise money, primarily for long-lived infrastructure assets. They obtain this money by
selling bonds to investors. In exchange, they promise to repay this money, with interest,
according to specified schedules.
International bonds
International bonds are debt instruments that are issued by a non-domestic company in order
to raise money from international investors and are usually denominated in the currency of
the issuing country with the primary objective to attract more investors on a large scale.
Types of International Bonds
1) Foreign bonds and Euro bonds 2) Global bonds 3) Straight Bonds 4) Floating-rate Bond 5)
Floatingrate Bonds 6) Convertible bonds 7) Cocktail bonds
i) Foreign bonds and Euro bonds
Foreign Bond is a bond where foreign company issues bond denominated in the currency
denomination of the foreign country. For example, an US company issues bond and raises
capital in Japan denominated in Japanese Yen. In other words, the Japanese investors are not
exposed to foreign exchange risk while investing in a foreign bond. At this junction it is
important to understand that a Japanese company may also issue bond and raise capital in
Japan denominated in Japanese Yen. But bonds issued by the Japanese company are termed
as ‗Domestic Bond‘. In case of a foreign bond, the bond issuer is from a foreign country. An
Indian company issuing USD bond in any country belonging to Middle East region is an
example of foreign bond.
In Euro bond, a foreign company issues a bond denominated in a currency which is not the
home currency of the investors. For example, an US company issues bond and raises capital
in Japan denominated in US Dollar. This will be an example Euro Bond. If the US company
issues bond in Pound sterling in Japan, it will also be considered as Euro Bond. In the earlier
case, it would be considered as a Euro Dollar Bond while in the later case, it would be known
as Euro Sterling Bond. Historical development of Eurobond market is attributed to the
unfavorable tax regime in USA during 1960s. This forced companies to issue USD
denominated bond outside USA. The First Eurobond was done in 1963.
ii) Global bonds
Though very few companies have issued these bonds. In a global bond issue, the issuer offers
the bonds to investors of many countries at one go. Normally these bonds are denominated in
multiple currencies. Global bonds are normally issued by large multinational or transnational
companies or as sovereign bonds. Global bonds can have following differences among issuer,
denomination and the country in which it is being issued:
• Issuer (Issuing company‘s nationality)
• What is the denomination of bonds (currency) and for which country this currency is
local?
• The country in which it is being issued
An example would be an Australian Bank (A) issuing a GBP Bond (B‘s currency) in London
(B‘s country) and in Japan (C). These bonds are large
• Possess high ratings
• Issued for simultaneous placement in various nations
• Traded in various regions on the basis of home market
Global bonds are sometimes also called Eurobonds but they have additional features. A
Eurobond is an international bond that is issued and traded in countries other than the country
in which the bond‘s currency or value is denominated. These bonds are issued in a currency
that is not the domestic currency of the issuer.
iii) Straight Bonds
A straight bond is a bond that pays interest at regular intervals, and at maturity pays back the
principal that was originally invested. A straight bond has no special features compared to
other bonds with embedded options. U.S. Treasury bonds issued by the government are
examples of straight bonds. A straight bond is also called a plain vanilla bond or a bullet
bond.
The features of a straight bond include constant coupon payments, face value or par value,
purchase value, and a fixed maturity date. A straight bondholder expects to receive periodic
interest payments, known as coupons, on the bond until the bond matures. At maturity date,
the principal investment is repaid to the investor. The return on principal depends on the
price that the bond was purchased for. If the bond was purchased at par, the bondholder
receives the par value at maturity. If the bond was purchased at a premium to par, the
investor will receive a par amount less than his or her initial capital investment. Finally, a
bond acquired at a discount to par means that the investor‘s repayment at maturity will be
higher than his or her initial investment.
Types of straight bond a) Bullet-redemption bond
A bullet bond is a debt instrument whose entire principal value is paid all at once on the
maturity date, as opposed to amortizing the bond over its lifetime. Bullet bonds cannot be
redeemed early by an issuer, which means they are non-callable.
b) Rising coupon bond
A bond with interest coupons that change to preset levels on specific dates. More specifically,
the bond pays a given coupon for a specific period of time, and then its coupon is stepped up
in regular periods until maturity. For instance, a bond may pay 6% interest for the next five
years, and thereafter interest payment increases by an additional 2% every next five years
until the bond matures. Typically, issuers embed rising-coupon bonds with call options which
give them the right to redeem the bonds at par on the date the coupon is set to step up.
This bond is also known as a dual-coupon bond, a stepped-coupon bond, or a step-up
coupon bond.
c) Zero-coupon bond
A zero-coupon bond is a debt security that does not pay interest but instead trades at a deep
discount, rendering a profit at maturity, when the bond is redeemed for its full face value.
Some bonds are issued as zero-coupon instruments from the start, while others bonds
transform into zero coupon instruments after a financial institution strips them of their
coupons, and repackages them as zero coupon bonds. Because they offer the entire payment
at maturity, zero-coupon bonds tend to fluctuate in price, much more so than coupon bonds.
A zero-coupon bond is also known as an accrual bond.
d) Bonds with currency option
The investor possesses the right for receiving the payments in a currency except the
currency of issue
e) Bull and bear bonds
A bull bond is a term used to refer to a bond that is likely to increase in value in a bull
market. Most bonds tend to increase in value when interest rates decline, but bull bonds refer
to types of bonds that do especially well in this environment. A bull bond is a specific type of
bond that performs well in a bull market. The bull bond increases as interest rates decline,
which distinguishes it from many other types of bonds, most of which tend to increase in
price when interest rates are rising.
A bull market is a financial market marked by optimism and investor confidence. The term
bull market, associated with trading in the stock market, can also apply to anything traded,
such as bonds, currencies, and commodities.
4) Floating-rate Bonds
• Floating rate bonds pay coupon based on some reference interest rate, such as LIBOR.
• Unlike coupon bonds, floating rate notes do not carry a fixed nominal interest rate.

• The coupon payments are linked to the movement in a reference interest rate (frequently
money market rates, such as the LIBOR) to which they are adjusted at specific intervals,
typically on each coupon date for the next coupon period.
 • The coupon of a floating rate bond is frequently defined as the sum of the reference
interest rate and a spread of x basis points.
• Floating rate bonds may be viewed as zero coupon bonds with a face value equaling the
sum of the forthcoming coupon payment and the principal because their regular interest
rate adjustments guarantee interest payments in line with market conditions
A floating rate note (FRN) is a debt instrument whose coupon rate is tied to a benchmark rate
such as LIBOR or the US Treasury Bill rate. Thus, the coupon rate on a floating rate note is
variable. It is typically composed of a variable benchmark rate + a fixed spread.
The rate is adjusted monthly or quarterly in relation to the benchmark. The maturity period of
FRN‘s vary but are typically in the range of two to five years.
FRN‘s are issued by governments, as well as private companies and financial institutions.
The notes are typically traded over-the-counter.
iv) Convertible Bonds
Convertible bonds are corporate bonds that can be converted by the holder into the common
stock of the issuing company. a convertible bond gives the holder the option to convert or
exchange it for a predetermined number of shares in the issuing company. When issued, they
act just like regular corporate bonds, albeit with a slightly lower interest rate.
Because convertibles can be changed into stock and, thus, benefit from a rise in the price of
the underlying stock, companies offer lower yields on convertibles. If the stock performs
poorly, there is no conversion and an investor is stuck with the bond's sub-par return-below
what a non-convertible corporate bond would get. As always, there is a tradeoff between risk
and return.
v) Cocktail bonds
Composite currency bonds are denominated in a currency basket, such as SDRs or ECUs,
instead of a single currency. They are frequently called currency cocktail bonds. They are
typically straight fixed-rate bonds. The currency composite is a portfolio of currencies: when
some currencies are depreciating others may be appreciating, thus yielding lower variability
overall.

Parallel Loans
Parallel loan is a four-party agreement in which two parent companies in different countries
borrow money in their local currencies, then lend that money to the other's local subsidiary.
The purpose of a parallel loan is to avoid borrowing money across country lines with possible
restrictions and fees. Each company can certainly go directly to the foreign exchange market
(forex) to secure their funds in the proper currency, but they then would face exchange risk.
The first parallel loans were implemented in the 1970s in the United Kingdom in order to
bypass taxes that were imposed to make foreign investments more expensive. Nowadays,
currency swaps have mostly replaced this strategy, which is similar to a back-to-back loan.
For example, say an Indian company has a subsidiary in the United Kingdom and a U.K. firm
has a subsidiary in India. Each firm's subsidiary needs the equivalent of 10 million British
pounds to finance its operations and investments. Rather than each company borrowing in its
home currency and then converting the funds into the other currency, the two parent firms
enter into a parallel loan agreement. The Indian company borrows 909,758,269 rupees (the
equivalent of 10 million pounds) from a local bank. At the same time, the British company
borrows 10 million pounds from its local bank. They each then loan the money to the other's
subsidiaries, agreeing on a defined period of time and interest rate (most loans of this type
come due within 10 years). At the end of the term of the loans, the money is repaid with
interest, and the parent companies repay that money to their home banks. No exchange from
one currency to the other was needed and, therefore, neither the two subsidiaries nor their
parent firms were exposed to currency risk due to fluctuations in the rupee/pound exchange
rate.
Companies might also directly make loans to each other, skipping the use of banks
altogether. When the loan term ends, the company repays the loan at the fixed rate agreed
upon at the beginning of the loan term, thereby ensuring against currency risk during the term
of the loan.

International Cash Management

Cash has been defined in the Government Financial Statistics (GFS) manual.2 - cash on hand
refers to notes, coins, and deposits held on demand by government institutional units with a
bank or another financial institution. Cash equivalents are defined to be highly liquid
investments that are readily convertible to cash on hand.
Cash management is necessary because there are mismatches between the timing of
payments and the availability of cash. Even if the annual budget is balanced, with realistic
revenue and expenditure estimates, in-year budget execution will not be smooth, since both
the timing and seasonality of cash inflows (which depend in turn on tax and nontax flows,
and timing of grant or loan disbursements) and of expenditures can result in conditions of
temporary cash surpluses or temporary cash shortfalls. For example, if taxes are paid
quarterly, there can be large temporary cash surpluses around the time taxes are due, and
temporary deficits in other time periods. Storkey (2003) provides the following definition:
―cash management is having the right amount of money in the right place and time to meet
the government‘s obligations in the most cost-effective way.‖ Other definitions emphasize
active cash management of temporary cash surpluses and temporary deficits.
Moderrn cash management has four major objectives:
• To ensure that adequate cash is available to pay for expenditures when they are due.
Pooling revenues in a treasury single account (TSA) facilitates this.
• To borrow only when needed and to minimize government borrowing costs.
• To maximize returns on idle cash, i.e., to avoid the accumulation of unremunerated or
low yielding government deposits in the central bank or in commercial banks.
• To manage risks, by investing temporary surpluses productively, against adequate
collateral. Effective cash management contributes to the smooth implementation of the
operational targets of fiscal policy, the public debt management strategy, and monetary
policy.
Approaches of Centralized Cash Management
a) Netting
In a typical multinational family of companies, there are a large number of intra-corporate
transactions between subsidiaries and between subsidiaries and the parent. If all the resulting
cash flows are executed on a bilateral, pair wise basis, a large number of currency
conversions would be involved with substantial transaction costs. With a centralized system,
netting is possible whereby the cash management center (CMC) nets out receivables
against payables, and only the net cash flows are settled among different units of the
corporate family.
Payments among affiliates go back and forth, whereas only a netted amount need be
transferred. For example, the German subsidiary of an MNC sells goods worth $1 million to
its Italian affiliate that in turn sells goods worth $2 million to the German unit. The combined
flows total $3 million. On the net basis, however, the German unit need remit only $1 million
to the Italian unit. This is called bilateral netting. It is valuable, though only if subsidiaries
sell back and forth to each other. But a large percentage of multinational transactions are
internal – leading to a relatively large volume of inter-affiliate payments – the payoff from
multilateral netting can be large, relative to he costs of such a system.
The netting center will use a matrix of payables and receivables to determine the net payer or
creditor position of each affiliate at the date of clearing.
b) Cash Pooling
The CMC act not only as a netting center but also the repository of all surplus funds. Under
this system, all units are asked to transfer their surplus cash to the CMC, which transfers
them among the units as needed and undertakes investment of surplus funds and short-term
borrowing on behalf of the entire corporate family. The CMC can in fact function as a
finance company which accepts loans from individual surplus units, makes loans to deficit
units and also undertakes market borrowing and investment. By denominating the intra-
corporate loans in the units‘ currencies, the responsibility for exposure management is
entirely transferred to the finance company and the operating subsidiaries can concentrate on
their main business, viz. production and selling of goods and services. Cash pooling will also
reduce overall cash needs since cash requirements of individual units will not be
synchronous.
c) Collection and Disbursement of Funds
Accelerating collections both within a foreign country and across borders is a key element of
international cash management. Considering either national or international collections,
accelerating the receipt of funds usually involves the following:
• defining and analyzing the different available payment channels,
• selecting the most efficient method (which can vary by country and customer),
• giving specific instructions regarding procedures to the firm‘s customers and banks.
Management of disbursements is a delicate balancing act of holding onto funds versus
staying on good terms with suppliers. It requires a detailed knowledge of individual country
and supplier policies, as well as the different payment instruments and banking services
available around the world. A constant review on disbursements and auditing of payment
instruments help international firms achieve better cash management.
Accounts Receivables management
Meaning of the receivables management: The receivables out of the credit sales crunch the
availability of the resources to meet the day today requirements. The acute competition
requires the firm to sustain among the other competitors through more volume of credit sales
and in the intention of retaining the existing customers. This requires the firm to sell more
through credit sales only in order to encourage the buyers to grab the opportunities unlike the
other competitors they offer in the market.
Objectives of Accounts Receivables
Achieving the growth in the volume of sales
Increasing the volume of profits
Meeting the acute competition
Cost of Maintaining the Accounts Receivables
Capital cost: Due to in sufficient amount of working capital with reference to more volume
of credit sales which drastically affects the existence of the working capital of the firm. The
firm may be required to borrow which may lead to pay certain amount of interest on the
borrowings. The interest which is paid by the firm due to the borrowings in order to meet the
shortage of working capital is known as capital cost of receivables.
Administrative cost: Cost of maintaining the receivables.
Collection cost: Whatever the cost incurred for the collection of the receivables are known as
collection cost.
Defaulting cost: This may arise due to defaulters and the cost is in other words as cost of bad
debts and so on.
Factors Affecting the Accounts Receivables
• Level of sales: The volume of sales is the best indicator of accounts receivables. It differs
from one firm to another.
• Credit policies: The credit policies are another major force of determinant in deciding
the size of the accounts receivable. There are two types of credit policies viz lenient and
stringent credit policies.
• Lenient credit policy: Enhances the volume of the accounts receivable due to liberal
terms of the trade which normally encourage the buyers to buy more and more.
• Stringent credit policy: It curtails the motive buying the goods on credit due stiff terms
of the trade put forth by the supplier unlike the earlier.
• Terms of trade: The terms of the trade are normally bifurcated into two categories viz
credit period and cash discount
• Credit period: Higher the credit period will lead to more volume of receivables, on the
other side that will lead to greater volume of debts from the side of buyers.
• Cash discount: If the discount on sales is more, that will enhance the volume of sales on
the other hand that will affect the income of the enterprise.
Management of Accounts Payable/Financing the Resources is more important at par with
the management of receivable, in order to avail the short term resources for the smooth
conduct of the firm.

Inventory management
Inventory management refers to the process of ordering, storing, and using a company's
inventory. These include the management of raw materials, components, and finished
products, as well as warehousing and processing such items.
For companies with complex supply chains and manufacturing processes, balancing the risks
of inventory gluts and shortages is especially difficult. To achieve these balances, firms have
developed two major methods for inventory management: just-in-time and materials
requirement planning: just-in-time (JIT) and materials requirement planning (MRP).
An inventory account typically consists of four separate categories:
• Raw materials
• Work in process
• Finished goods
• Merchandise
• Raw materials
Raw materials represent various materials a company purchases for its production process.
These materials must undergo significant work before a company can transform them into a
finished good ready for sale.
Work in process
Works-in-process represent raw materials in the process of being transformed into a finished
product.
Finished goods
Finished goods are completed products readily available for sale to a company's customers.
Merchandise
Merchandise represents finished goods a company buys from a supplier for future resale.
The objectives of inventory management
The objectives of inventory management are to provide the desired level of customer service,
to allow cost-efficient operations, and to minimize the inventory investment.
Customer Service
Customer service is a company's ability to satisfy the needs of its customers. When we talk
about customer service in inventory management, we mean whether or not a product is
available for the customer when the customer wants it. In this sense, customer service
measures the effectiveness of the company's inventory management. Customers can be either
external or internal: any entity in the supply chain is considered a customer.