Theories of International Financial Management

MARGARET K.

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Theories of International Financial Management

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Abstract

The purpose of this management report will be to critically examine the main theories of international financial management and assess the extent to which these theories can be used in the real world. This will be a critical examination of any empirical evidence that exists on the theories used to explain international financial management which include the fisher effects theory, international fisher effects theory, purchasing power parity theory, Mundell-Fleming model theory, optimum currency area theory and the interest rate parity theory. The report will evaluate these theories based on their applicability to real world situations and offer suitable recommendations that will be used to improve the performance of these theories to international finance activities.

International finance is an important branch of economics that explains how exchange rates, interest rates and other aspects of international finance affect the movement of goods across borders. The field of economics also assesses capital flows of financial information as well as international investments and trade deficits (Siddaiah 2010). The theories that are used to explain international finance include the Mundell-Fleming model, the optimum currency area (OCA) theory, the purchasing power parity (PPP) theory, the fisher effects theory, international fisher effect theory and the interest rate parity (IRP) theory (Madura 2008). The theories that will be analyzed in this report will be the Mundell-Fleming model, the purchasing power parity theory and the optimum currency area.

Executive Summary
1. A brief overview of the contents of the management report
Introduction
1. ]A brief introduction of international financial management as well as the theories that are used to explain this concept
Mundell-Fleming Theory
1. This section will highlight the assumptions that form the basis for this theory of international finance as well as its application in the real world
Optimum Currency Area
1. The theory will be explained and evaluated on the basis of its real life application to realistic situations
Purchasing Power Parity
1. The various models/versions that make up this theory will be explained as well as the assumptions that form the foundational basis
Recommendations and Conclusions
1. Recommendations on how these theories can be adjusted to reflect real world situations will be provided. The conclusion will be a summary of the report

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[...] This index has been deemed to be very useful because it has its basis on a well-known product whose final price includes input costs from a wide range of sectors in the local economy such as the transport, agricultural and manufacturing sector. The Big Mac Index basically tests the validity and feasibility of the law of one price which is one of the assumptions guiding the purchasing power parity (Economist 2004). The purchasing power parity theory is made up of two versions which include the absolute version and the relative version of purchasing power parity. [...]

[...] Working Paper No.10. [...]

[...] New Jersey: Prentice Hall Cashin, P., McDermott, J., and McDermott, P., (2001) An unbiased appraisal of purchasing power parity, issues 2001-2196. New Zealand: International Monetary Fund DeGrauwe, P., (2000) Economics of monetary union. New York: Oxford University Press Economist (2004) Burgers or beans? a new theory is percolating through the foreign- exchange markets. Available at: http://www.economist.com/node/2361072?story_id=E1_NPGTDSN [Accessed 11 May 2011] Frankel, J.A., and Andrew, K., (2001) The endogenity of the optimum currency area criteria. The Economic Journal, Vol No pp 1009-1025 Gamber, E., and Colander, D.C., (2006) Macroeconomics. [...]

[...] Cape Town, South Africa: Pearson South Africa Inter Economics (2009) Optimum currency areas and the European experience. Currency Unions-1. Available at: http://www.intereconomics.com/students/classes/239110KSpdf/LectureS09h. pdf Kevin, M., (2009) Fundamentals of international financial management. New Delhi: PHI Learning Private Limited Kouparitsas, M.A., (2001) Is the United States an optimum currency area? An empirical analysis of regional business cycles. Federal Reserve Bank of Chicago Working Paper 2001-21 Krugman, P., and Obstfeld, M., (2009) International economics. California: Pearson Education Madura, J., (2008) International financial management. [...]

[...] Openness with capital mobility and flexibility of wages across regions is another important criterion for optimal currency areas because it influences the automatic distribution of money and goods to areas where they are needed. The third criteria for OCA is a risk sharing system between countries such as an automatic fiscal transfer mechanism that redistributes money to areas that fall under OCA (Ricci 2008). The final criterion requires that participant countries should have similar business cycles where in the event one country in the optimal currency area experiences a recession or economic growth the rest are meant to experience the same effect. [...]

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