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CHAPTER 19 Multinational Financial Management


CHAPTER 19 Multinational Financial Management Multinational vs. domestic financial management Exchange rates and trading in foreign exchange – PowerPoint PPT presentation

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Title: CHAPTER 19 Multinational Financial Management

CHAPTER 19Multinational Financial Management
  • Multinational vs. domestic financial management
  • Exchange rates and trading in foreign exchange
  • International money and capital markets

What is a multinational corporation?
  • A corporation that operates in two or more
  • Decision making within the corporation may be
    centralized in the home country, or may be
    decentralized across the countries the
    corporation does business in.

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.
  5. To avoid political and regulatory hurdles.
  6. To diversify.

What factors distinguish multinational financial
management from domestic financial management?
  1. Different currency denominations.
  2. Economic and legal ramifications.
  3. Language differences.
  4. Cultural differences.
  5. Role of governments.
  6. Political risk.

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
  • Since they are prices of foreign currencies
    expressed in dollars, they are direct quotations.

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
  • Most exchange rates are stated in terms of an
    indirect quotation.
  • Except the British pound, which is usually in
    terms of a direct quotation.

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 quotations.

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.
  • Cross rate between Australian dollar and the
    Japanese yen.
  • Cross rate (Yen / US Dollar) x (US Dollar / A.
  • 111.11 x 0.650
  • 72.22 Yen / A. Dollar
  • The inverse of this cross rate yields
  • 0.0138 A. Dollars / Yen

Orange juice projectSetting the appropriate
  • 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?
  • Price (1.75)(1.50)(111.11)
  • 291.66 yen

Orange juice projectDetermining 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
  • U.S. dollar profit 2.55 / 1.5385 1.66

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 system is a
    floating rate system.

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 European Central
    Bank controls the monetary policy of the EMU.

Member nations of the EMU
  • Austria
  • Belgium
  • Finland
  • France
  • Germany
  • Greece
  • Ireland
  • Italy
  • Luxembourg
  • Netherlands
  • Portugal
  • Spain
  • Notable European Union countries not in the EMU
  • Britain, Sweden, and Denmark

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 traded in world
    currency markets.

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 to export to
    their home countries.

What is difference between spot rates and forward
  • Spot rates are the rates to buy currency for
    immediate delivery.
  • Forward rates are the rates to buy currency at
    some agreed-upon date in the future.

When is the forward rate at a premium to the spot
  • 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 spot/forward rate
    relationship is relative interest rates.

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
  • ft 0.0095
  • kh 4 / 12 0.333
  • kf 4 / 12 0.333

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.

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
  • 30-day return 59.07/1,000 5.907, nominal
    annual return 12 x 5.907 70.88.

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)
  • -OR-
  • e0 Ph/Pf

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
  • 3.0769 Australian dollars.

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 increases over the life of the loan.

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
  • Eurobonds sold in country other than the one in
    whose currency the bonds are denominated.

To what extent do average capital structures vary
across different countries?
  • Previous studies suggested that average capital
    structures vary among the large industrial
  • However, a recent study, which controlled for
    differences in accounting practices, suggests
    that capital structures are more similar across
    different countries than previously thought.

Impact of multinational operations
  • Cash management
  • Distances are greater.
  • Access to more markets for loans and for
    temporary investments.
  • Cash is often denominated in different currencies.

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.
  • Funds repatriated must be converted to U.S.
    dollars, so exchange rate risk must be taken into

Impact of multinational operations
  • Credit management
  • Credit is more important, because commerce to
    lesser-developed countries often relies on
  • 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,
    carrying costs, taxes, import duties, and
    exchange rates.