Master of Business Administration - Semester 4MB0053: “International Business Management”

(4 credits)(Book ID: B1315)

ASSIGNMENT- Set 1

1. What is globalisation and what are its benefits?

Globalisation is a process where businesses are dealt in markets around the world, apart from the local and national markets. According to business terminologies, globalisation is defined as ‘the worldwide trend of businesses expanding beyond their domestic boundaries’. It is advantageous for the economy of countries because it promotes prosperity in the countries that embrace globalisation.

Benefits of globalisation The merits and demerits of globalisation are highly debatable. While globalisation creates employment opportunities in the host countries, it also exploits labour at a very low cost compared to the home country. Let us consider the benefits and ill-effects of globalisation. Some of the benefits of globalisation are as follows: Promotes foreign trade and liberalisation of economies.

Increases the living standards of people in several developing countries through capital investments in developing countries by developed countries.

Benefits customers as companies outsource to low wage countries. Outsourcing helps the companies to be competitive by keeping the cost low, with increased productivity.

Promotes better education and jobs.

Leads to free flow of information and wide acceptance of foreign products, ideas, ethics, best practices, and culture.

Provides better quality of products, customer services, and standardised delivery models across countries.

Gives better access to finance for corporate and sovereign borrowers.

Increases business travel, which in turn leads to a flourishing travel and hospitality industry across the world.

Increases sales as the availability of cutting edge technologies and production techniques decrease the cost of production.

Provides several platforms for international dispute resolutions in business, which facilitates international trade.

2. Discuss in brief the Absolute and comparative cost advantage theories.

Absolute advantage Adam Smith (a social philosopher and a pioneer of politicl economics) argued that nations differ in their ability to manufacture goods efficiently and he saw that a country gains by trading. If the two countries exchanged two goods at a ratio of 1:1, country I gets one unit of goods B by sacrificing only 10 units of labour, whereas it has to give up 20 units of labour if it produced the goods itself. In the same manner, country II gives up only 10 units of labour to get one unit of goods A, whereas it has to give up 20 units of labour if it was made by itself. Hence, it was understood that both countries had large amount of both goods by trading. Comparative advantage Ricardo (english political economist) questioned Smith’s theory stating that if one country is more productive than the other in all lines of production and if country I can produce all goods with less labour costs, will there be a need for the countries to trade. The reply was affirmative.He used England and Portugal as examples in his demonstration, the two goods they produced being wine and cloth. This case is explained using table 2.1 and 2.2.

Labour cost of production (in hours) 1 unit of wine 1 unit of cloth Portugal 70 80 England 110 90

Table 2.1: Cost Comparison

According to him, Portugal has an advantage in both areas of manufacture. To demonstrate that trade between both countries will lead to gains, the concept of opportunity cost (OC) is introduced. The OC for good X is the amount of other goods that have to be given up in order to produce one additional unit of X.

Opportunity costs for Wine clothPortugal 70/80 = 7/8 80/70 = 8/7England 110/90 = 11 /9 90/110 = 9/11

Table 2.2: Opportunity CostsA country has a comparative advantage in producing goods if the OC is lower at home than in the other country. The table shows that Portugal has the lower OC of the 2 countries in wine-making while England has the lower OC in making cloth. Thus Portugal has the comparative advantage in the production of wine whereas England has one one in the production of cloth.

3. How is culture an integral part of international business. What are its elements? Significance of country culture Every society has its own unique culture. Culture must not be imposed on individuals of different culture. For example, the Cadbury Kraft Acquisition, 2009 was a landmark international deal, in which a U.S. based company Kraft acquired the British chocolate giant, Cadbury which were in complete extremes in terms of culture. Let us discuss the major cultural elements that are related to business.Cultural elements that relate business

The most important cultural components of a country which relate business transactions are: Language.

Religion.

Conflicting attitudes.

Language Language is something more than just spoken and written words. Gestures, non-verbal communication, facial expressions, and body language all communicate a message. An interpreter is used when two people do not speak common language. Failure in understanding the cultural context when non-verbal communication takes place or failure in reading the person across the table results in sending a wrong signal. Religion The dominant religious beliefs within a culture have a great impact on a person’s approach to business than most people expect, even if that person is not a follower of a specific culture. Conflicting attitudes Cultural values have a massive effect on the way business is carried out. The cultural values that are evident in everyday life are not only shown in business but they are exaggerated. If the cultural basics are not understood, then there is possibility that a deal ends even before the negotiations start.

4. Describe the tools and methods of country risk analysis.

Methodology of country risk analysisCountry detailed risk refers to the unpredictability of returns on international business transactions in view of information associated with a particular country. The techniques used by the banks and other agencies for country risk analysis can be classified as qualitative or quantitative. Many agencies merge both qualitative and quantitative information into a single rating. A survey conducted by the US EXIM bank classified the various methods of country risk assessment used by the banks into four types. They are:

Fully qualitative method - The fully qualitative method involves a detailed analysis of a country. It includes general discussion of a country’s economic, political, and social conditions and prediction. Fully qualitative method can be adapted to the unique strengths and problems of the country undergoing evaluation.

Structured qualitative method – The structured method uses a uniform format with predetermined scope. In structured qualitative method, it is easier to make comparisons between countries as it follows a specific format across countries. This technique was the most popular among the banks during the late seventies.

Checklist method - The checklist method involves scoring the country based on specific variables that can be either quantitative, in which the scoring does not need personal judgment of the country being scored or qualitative, in which the scoring needs subjective determinations. All items are scaled from the lowest to the highest score. The sum of scores is then used to determine the country risk.

Delphi technique – The technique involves a set of independent opinions without group discussion. As applied to country risk analysis, the MNC can assess definite employees who have the capability to evaluate the risk characteristics of a particular country. The MNC gets responses from its evaluation and then may determine some opinions about the risk of the country.

Inspection visits – Involves travelling to a country and conducting meeting with government officials, business executives, and consumers. These meetings clarify any vague opinions the firm has about the country.

Other quantitative methods – The quantitative models used in statistical studies of country risk analysis can be classified as discriminant analysis, principal component analysis, logit analysis and classification and regression tree method.

Data sourcing The basic data is important to analyse a country. The economic, financial and currency risk components are based on the variables (quantitative and qualitative variables). The variables must consider the particularities of each country and the needs of the model used. The standard variables are used to maintain the regular analysis comparable with similar works of other countries. Therefore, the first step is to make sure that the historical series of official data are reliable, consistent and comparable. The standard economic variables that are found mainly in the varied approach adopted by financial institutions and rating agencies, are associated with the country’s real ability to repay its commitments. The balance of payments (summary account of economic transactions among a country and the others nations of the world, during a period) and its evolution through the years means a strong source of data. The exchange rate (currency risk) is another important variable considered, as it balances the transactions (balances the prices of goods, services, and capital) between residents and non-residents. The analysis must consider the historical behavior of the exchange rate and the policy which made clear whether the country follows a rational economics approach or it uses the exchange rate as a tool to maintain a forced macroeconomic equilibrium. Apart from the macroeconomic variables which deal with the external sector of the economy, there are some other relevant variables such as the interest rate, level of investments, public debt and its service, internal savings, consumption, GDP or GNP, money supply, inflation rate and so on. The analysis must be accomplished with qualitative variables, which consider social aspects as population, life expectancy, rate of birthday, rate of unemployment, level of literacy and so on. The social-political aspects are necessary for all kind of analysis as they describe the whole setting of the running economy.

Tools The risk management demands a regular follow up regarding governmental policies, external and internal environment, outlook provided by rating agencies, and so on. Following are the tools recommended: Chain of value - Includes the main countries that sustain trade relationships with the nation, broken by sectors and products.

Strength and weakness chart - Focus the key aspects that warn the country.

Table of financial markets performance - Follow up the behavior of bonds and stocks already issued and to be issued.

Table of macroeconomic variables - Provides alert signals when the behavior of any ratio presents a relevant change.

5. Write short notes on: a. Spot and forward contracts

b. Foreign currency derivatives

a. Spot and Forward contracts - A Spot contract is a binding obligation to buy or sell a definite amount of foreign currency at the existing or spot market rate. A forward contract is a binding obligation to buy or sell a definite amount of foreign currency at the pre-agreed rate of exchange, on or before a certain date. The advantage of spot dealing has resulted in a simplest way to deal with all foreign currency requirements. It carries the greatest risk of exchange rate fluctuations due to lack of certainty of the rate until the deal is carried out. The spot rate that is intended to receive will be set by current market conditions, the demand and supply of currency being traded and the amount to be dealt. In general, a better spot rate can be received if the amount of dealing is high. The spot deal will come to an end in two working days after the deal is struck. A forward market needs a more complex calculation. A forward rate is based on the existing spot rate plus a premium or discounts which are determined by the interest rate connecting the two currencies that are involved. For example, the interest rates of UK are higher than that of US and therefore a modification is made to the spot rate to reflect the financial effect of this differential over the period of the forward contract. The duration will be up to two years for a forward contract. A variation in foreign exchange markets can be affected to any company whether or not they are directly involved in the international trade or not. This is often referred to as ‘Economic’ foreign exchange and most difficult to protect a business. The three ways of managing risks are as follows: Choosing to manage risk by dealing with the spot market whenever the need of cash flow rises. This will result in a high risk and speculative strategy since one will not know the rate at which a transaction is dealt until the day and time it occurs. Managing the business becomes difficult if it depends on the selling or buying the currency in the spot market.

The decision must be made to book a foreign exchange contract with the bank whenever the foreign exchange risk is likely to occur. This will help to fix the exchange rate immediately and will give a clear idea of knowing the exact cost of foreign currency and the amount to be received at the time of settlement whenever this due occurs.

A currency option will prevent unfavourable exchange rate movements in the similar way as a forward contract does. It will permit gains if the markets move as per the expectations. For this base, a currency option is often demonstrated as a forward contract that can be left if it is not followed. Often banks provide currency options which will ensure protection and flexibility, but the likely problem to arise is the involvement of premium of particular kind. The premium involved might be a cash amount or it could also influence into the charge of the transaction.

b. Foreign currency derivatives Currency derivative is defined as a financial contract in order to swap two currencies at a predestined rate. It can also be termed as the agreement where the value can be determined from the rate of exchange of two currencies at the spot. The currency derivative trades in

markets correspond to the spot (cash) market. Hence, the spot market exposures can be enclosed with the currency derivatives. The main advantage from derivative hedging is the basket of currency available. Figure A describes the examples of currency derivatives. The derivatives can be hedged with other derivatives. In the foreign exchange market, currency derivatives like the currency features, currency options and currency swaps are usually traded. The standard agreement made in order to buy or sell foreign currencies in future is termed as currency futures. These are usually traded through organised exchanges. The authority to buy or sell the foreign currencies in future at a specified rate is provided by currency option. These will help the businessmen to enhance their foreign exchange dealings. The agreement undertaken to exchange cash flow streams in one currency for cash flow streams in another currency in future is provided by currency swaps. These will help to increase the funds of foreign currency from the cheapest sources.

6. Discuss the importance of transfer pricing for MNCs.

Swaps

Options of futures Forwards

Futures Cash options

Spot (Dutsche mark)

Peg (European currency unit)

Importance of transfer pricing Transfer pricing is the process of setting a price that will be charged by a subsidiary (unit) of a multi-unit firm to another unit for goods and services, which are sold between such related units. Transfer pricing is a critical issue for a firm operating internationally. Transfer pricing is determined in three ways: market based pricing, transfer at cost and cost-plus pricing. The Arm’s Length pricing rule is used to establish the price to be charged to the subsidiary. Transfer pricing can also be defined as the rates or prices that are utilised when selling goods or services between a parent company and a subsidiary or company divisions and departments that may be across many countries. The price that is set for the exchange in the process of transfer pricing may be a rate that is reduced due to internal depreciation or the original purchase price of the goods in question. When properly used, transfer pricing helps to efficiently manage the ratio of profit and loss within the company. Transfer pricing is a relatively simple method of moving goods and services among the overall corporate family. Many managers consider transfer pricing as non-market based. The reason for transfer pricing may be internal or external. Internal transfer pricing include motivating managers and monitoring performance. External factors include taxes, tariffs, and other charges. Transfer Pricing Manipulation (TPM) is used to overcome these reasons. Governments usually discourage TPM since it is against transfer pricing, where transfer pricing is the act of pricing commodities or services. However, in common terminology, transfer pricing generally refers TPM. TPM assists in saving the organisation’s tax by shifting accounting profits from high tax to low tax jurisdictions. It also enables to fix transfer price on a non-market basis and thus enables to save tax. This method facilitates in moving the tax revenues of one country to another. A similar trend can be observed in domestic markets where different states try to attract investment by reducing the Sales tax rates, and this leads in an outflow from one state to another. Therefore, the Government is trying to implement a taxing system in order to curb tax evasion.