International Financial Management
What the exam tests
International financial management tests multinational capital budgeting, international parity conditions, foreign currency financing, country risk, transfer pricing and cross-border investment decisions.
Core rules
- Purchasing power parity: expected spot ≈ spot × (1 + domestic inflation)/(1 + foreign inflation).
- Interest rate parity links forward premiums to interest differentials; the international Fisher effect links nominal rates to expected inflation.
- Evaluate foreign projects on incremental home-currency cash flows, with repatriation restrictions and taxes considered; discount at a risk-adjusted rate reflecting country and currency risk.
- Political risk can be managed by structuring, insurance, local financing and staged investment.
- ADRs, GDRs, ECBs and foreign bonds differ in regulation, currency and investor base.
Worked example
Spot = ₹80/US$, Indian inflation = 6%, US inflation = 2%. One-year PPP expected spot = 80 × 1.06/1.02 = ₹83.14/US$. If the one-year forward is ₹82.50, the dollar is cheaper forward than PPP suggests; an importer may prefer the forward, while a speculator expecting PPP would buy dollars forward. PPP is a long-run anchor, not a precise short-term forecast.
Traps
Using PPP to price a one-month forward when interest rates dominate; double-counting country risk by adding a premium to cash flows and discount rate; ignoring blocked funds and withholding tax; confusing real and nominal exchange rates.