International Finance is a section of financial economics which deals with the macro-economic relation between two countries and their monetary transactions. The concepts like interest rate, exchange rate, FDI, FPI and currency prevailing in the trade come under this type of finance.
- We live in a globalized world. Every country is dependent on another country in some other means. Developed countries look for the cheap workforce from developing countries and developing countries look for services and products from developing countries.
- When a trade happened between two countries as in this case, there are many factors that come into the picture and have to be considered while the execution of the trade so that no violation of regulation happens. For any economy international finance is a significant critical factor, the local government should accordingly execute the policies so that the local players are not facing severe competition from the non-local players.
International Finance Examples
- The Bretton woods system was suggested in the year 1944 as the first common negotiated monetary order to facilitate the monetary transactions among two different countries.
- In Bretton Woods’s system, the member countries agreed to take care of their trade transactions across the borders and settle the bill in dollar-denominated bills which could be exchanged for that equivalent of gold.
- This was the reason for quoting these bills to be “As good as gold”. Every currency of the member countries like Canada, EU, Australia, and Japan was pegged against the common universal currency USD.
- The USA ended this in the year 1971. The conversion of US dollars to gold was unilaterally terminated, with this the US along with other mixed currency became floating currencies again.
- Trump’s policies to increase the duty on products from China are another classic real-time examples.
Scope of International Finance
As there are many prospects that come into the picture and there is the scope it books profits and benefits from each of these prospects accordingly.
- It is important while determining the exchange rates of the country. This can be done against the commodity or against the common currency.
- It plays a crucial role in investing in foreign debt securities to have a clear idea about the market.
- The transaction between countries can be significant in assessing the economic conditions of the other country.
- The arbitrage in tax, risk, and price due to market imperfectionsMarket ImperfectionsImperfect market structure is a part of microeconomics in which companies sell different products and services, as opposed to perfect competitive markets in which homogeneous products are sold. Companies in this sector have some pricing power with high barriers to entry, resulting in higher profit margins as each company tries to differentiate their products and services through innovative technology. can be used to book good profits while transacting in international trade.
Significance and Importance
- In a growing world which is moving towards globalization, its importance is just growing in magnitude. With every day the transaction between two countries for trade is scaling up with the supporting factors.
- It considers the world as a single market instead of individual markets and carries out the other procedures. For the same reason the firms, corporations doing such research include institutions like International Monetary fund (IMF), International Finance Corp (IFC), the World Bank. Trade between two foreign countries is one the factor for developing the local economy and improve economies of scaleEconomies Of ScaleEconomies of scale are the cost advantage a business achieves due to large-scale production and higher efficiency. .
- Currency fluctuations, arbitrageArbitrageArbitrage in finance means simultaneous purchasing and selling a security in different markets or other exchanges to generate risk-free profit from the security's price difference. It involves exploiting market inefficiency to generate profits resulting in different prices to the point where no arbitrage opportunities are left., interest rate, trade deficitTrade DeficitWhen the total sum of goods or services that a country imports from other countries is higher than the total sum of goods or services that a country exports to other countries, this is referred to as a trade deficit, which is the opposite of the balance of trade theory., and other international macroeconomic factors are crucial in prevailing scenarios.
International Finance vs Domestic Finance
- When all the business and economic transactionBusiness And Economic TransactionA business transaction is the exchange of goods or services for cash with third parties (such as customers, vendors, etc.). The goods involved have monetary and tangible economic value, which may be recorded and presented in the company's financial statements. occur within a domestic boundary of the country, it is said to be domestic finance and if the transactions occur across the international borders, refers to international finance.
- There are more than taxation, cultural, economic environment in international finance whereas it will same in domestic finance.
- Currency rate and derivatives of currency are involved usually in international finance whereas in domestic finance not many financial instruments as such are used.
- The stakeholders in domestic finance are usually uniform with a similar culture, language, and beliefs but in international finance, we can see diversity among the culture, language, and values of their stakeholders.
- There are literally numerous options to raise capital from international finance, hence the challenge will be high. Whereas in domestic finance not many options to raise capital will be there thus resulting in fewer challenges.
- The accounting standards need to be as per GAAPAs Per GAAPGenerally accepted accounting principles (GAAP) are the minimum standards and uniform guidelines for the accounting and reporting. These standards prohibit firms from engaging in unethical business activities and enable for a more accurate comparison of financial reports to investors. in terms of international finance, whereas there is no need to maintain separate ones in domestic finance.
- There is a range of options in international trade and finance to raise and manage the capital for the business.
- The scope of growth for companies concentrating on international trade is significantly high compared to companies that don’t.
- With different currencies involved and more opportunities to manage the capital involved, the financial performance of the company will be improved.
- The competitiveness of a market improves only when international trade is enabled in such markets. The quality of goods and services will improve without much difference in price due to competition.
- Revenue from international trade can act as a shield to the company and doesn’t have to worry about domestic demand as they have still demand from overseas.
- Company has operations in more than one country can act swiftly in case of emergencies and conduct BCP (Business Continuity Protocol)
- Political turmoil in one country which is a stakeholder of international tradeInternational TradeThe trading or exchange of products and/or services across international borders is referred to as international trade. It frequently includes other risk factors such as exchange rate, government policies, economy, laws of the other nation, judicial system, and financial markets that impact trade between the two. can affect the other stakeholder of the same trade-in another country.
- Depending on other country’s exchange rate is always risky given that all the currencies have significant volatility.
- The credit riskCredit RiskCredit risk is the probability of a loss owing to the borrower's failure to repay the loan or meet debt obligations. It refers to the possibility that the lender may not receive the debt's principal and an interest component, resulting in interrupted cash flow and increased cost of collection. because of international trade should be carefully managed, otherwise, it can hamper the profitability to a greater extent.
- It requires the disclosure of sensitive data more compared to domestic finance, the chance of confidential information being stolen is more in global markets.
- Local players cannot compete with global big players who are resource and research-backed to come up with quality products and services.
- As there is more than one culture involved, there will be cultural differences which if not tackled properly can damage the reputation of the brand.
- This is a concept that is growing significantly in the era of technology and globalization. The concept not just brings various opportunities for the company to manage capital more effectively but also increases the competition to produce and deliver quality goods and services. The local players will have to compete with global huge players, so there is the least scope of mistake in the quality of products.
- With many factors like exchange rate, inflation rate and diversity in culture and language the international finance can be a boon if managed perfectly by the company or become a bane if any of the aspects which are out of understanding and mismanaged. Thus, companies involved in such finance have no choice but to engage, they have to make sure they do it in an efficient manner.
This has been a guide to What is International Finance & its Definition. Here we discuss the significance, importance and it’s scope along with examples, benefits, and disadvantages. You can learn more about from the following articles –