CHAPTER 19
Multinational Financial
Management
Multinational vs. domestic financial
management
Exchange rates and trading in
What is a multinational
corporation?
A corporation that
operates in two or more countries.
Decision making within
the corporation may be centralized in the home country, or may be
decentralized across the countries the
Why do firms expand into
other countries?
1. To seek new markets. 2. To seek raw materials. 3. To seek new technology.
4. To seek production efficiency.
What factors distinguish
multinational financial management from domestic financial
management?
1. Different currency denominations. 2. Economic and legal ramifications. 3. Language differences.
Consider the following
exchange rates
US $ to buy 1 unit Japanese yen 0.009
Australian dollar 0.650
Are these currency prices direct or indirect
quotations?
Since they are prices of foreign
What is an indirect
quotation?
The number of units of a foreign
currency needed to purchase one U.S. dollar, or the reciprocal of a direct quotation.
Are you more likely to observe
direct or indirect quotations?
Most exchange rates are stated in
terms of an indirect quotation.
Except the British pound, which is
Calculate the indirect
quotations for yen and
Australian dollar
# of units of foreign currency per US $
Japanese yen 111.11
Australian dollar 1.5385
Simply find the inverse of the direct
What is a cross rate?
The exchange rate between any two
currencies. Cross rates are actually calculated on the basis of various currencies relative to the U.S. dollar.
Cross rate between Australian dollar and
the Japanese yen.
Cross rate = (Yen / US Dollar) x (US Dollar / A. Dollar)
= 111.11 x 0.650
= 72.22 Yen / A. Dollar
The inverse of this cross rate yields:
Orange juice project:
Setting the appropriate
price
A firm can produce a liter of orange
juice and ship it to Japan for $1.75 per unit. If the firm wants a 50%
markup on the project, what should the juice sell for in Japan?
Orange juice project:
Determining profitability
The product will cost 250 yen to
produce and ship to Australia, where it can be sold for 6 Australian dollars.
What is the U.S. dollar profit on the sale?
Cost in A. dollars = 250 yen (0.0138)
= 3.45 A. dollars
A. dollar profit = 6 – 3.45 = 2.55 A. dollars
What is exchange rate
risk?
The risk that the value of a cash flow in
one currency translated to another
currency will decline due to a change in exchange rates.
For example, in the last slide, a weakening
Australian dollar (strengthening dollar) would lower the dollar profit.
The current international monetary
European Monetary Union
In 2002, the full implementation
of the “euro” was completed. The national currencies of the 12 participating countries were phased out in favor of the
“euro.” The newly formed
Member nations of the
EMU
Austria Belgium Finland France
Germany Greece
Ireland Italy
Luxembourg Netherlands Portugal
Spain
Notable European Union
What is a convertible
currency?
A currency is convertible when
the issuing country promises to redeem the currency at current market rates.
Convertible currencies are
What problems may arise when a firm operates in a country
whose currency is not convertible?
It becomes very difficult for
multi-national companies to conduct
business because there is no easy way to take profits out of the
country.
Often, firms will barter for goods
What is difference
between spot rates and
forward rates?
Spot rates are the rates to buy
currency for immediate delivery.
Forward rates are the rates to
When is the forward rate
at a premium to the spot
rate?
If the U.S. dollar buys fewer units of a
foreign currency in the forward than in the spot market, the foreign
currency is selling at a premium.
In the opposite situation, the foreign
currency is selling at a discount.
The primary determinant of the
What is interest rate
parity?
Interest rate parity holds that investors
should expect to earn the same return in all countries after adjusting for risk.
Evaluating interest rate
parity
Suppose one yen buys $0.0095 in the
30-day forward exchange market and kNOM for a 30-day risk-free security in
Japan and in the U.S. is 4%.
f
t = 0.0095
k
h = 4% / 12 = 0.333%
k
Does interest rate parity
hold?
Therefore, for interest rate parity to
hold, e0 must equal $0.0095, but we
were given earlier that e0 = $0.0090. 1
e
0.0095
1.0033 1.0033 e
0.0095
0 0
Which security offers the
highest return?
The Japanese security.
Convert $1,000 to yen in the spot market. $1,000 x 111.111 = 111,111 yen.
Invest 111,111 yen in 30-day Japanese security. In 30 days receive 111,111 yen x 1.00333 =
111,481 yen.
Agree today to exchange 111,481 yen 30 days from now at forward rate, 111,481/105.2632 = $1,059.07.
What is purchasing power
parity (PPP)?
Purchasing power parity implies that
the level of exchange rates adjusts so that identical goods cost the
same amount in different countries. Ph = Pf(e0)
If grapefruit juice costs $2.00 per liter in the U.S. and PPP holds,
what is the price of grapefruit juice in Australia?
e0 = Ph/Pf
$0.6500 = $2.00/Pf
Pf = $2.00/$0.6500
What impact does relative inflation have on interest rates and exchange rates?
Lower inflation leads to lower interest
rates, so borrowing in low-interest countries may appear attractive to multinational firms.
However, currencies in low-inflation
countries tend to appreciate against those in high-inflation rate countries, so the effective interest cost
International money and
capital markets
Eurodollar markets
a source of dollars outside the U.S.
International bonds
Foreign bonds – sold by foreign
borrower, but denominated in the currency of the country of issue.
Eurobonds – sold in country other
To what extent do average capital structures vary across different
countries?
Previous studies suggested that
average capital structures vary
among the large industrial countries.
However, a recent study, which
controlled for differences in
accounting practices, suggests that capital structures are more similar across different countries than
Impact of multinational
operations
Cash management
Distances are greater.
Access to more markets for loans
and for temporary investments.
Cash is often denominated in
Impact of multinational
operations
Capital budgeting decisions
Foreign operations are taxed locally, and then funds repatriated may be subject to U.S. taxes.
Foreign projects are subject to political risk.
Impact of multinational
operations
Credit management
Credit is more important, because commerce to lesser-developed countries often relies on credit. Credit for future payment may be subject to
exchange rate risk.
Inventory management
Inventory decisions can be more complex, especially when inventory can be stored in locations in different countries.
Some factors to consider are shipping times,
