Transcript 16 - 1 CHAPTER 16 Multinational Financial Management Multinational vs. domestic financial management Exchange rates and trading in foreign exchange International monetary system International money and capital markets Copyright ©

16 - 1
CHAPTER 16
Multinational Financial Management
Multinational vs. domestic financial
management
Exchange rates and trading in
foreign exchange
International monetary system
International money and capital
markets
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16 - 2
What is a multinational corporation?
A corporation that operates in
two or more countries.
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16 - 3
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.
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16 - 4
What are the six major factors that
distinguish multinational 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.
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16 - 5
Consider the following exchange rates:
U.S. $ 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
currencies expressed in dollars,
they are direct quotations.
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What is an indirect quotation?
The number of units of foreign
currency needed to purchase one
U.S. dollar, or the reciprocal of a
direct quotation.
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Calculate the indirect quotations
for yen and Australian dollars.
# of Units of Foreign
Currency per U.S. $
Japanese yen
111.11
Australian dollar
1.5385
Yen:
1/0.009 = 111.11.
A. Dollar: 1/0.650 = 1.5385.
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16 - 8
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.
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16 - 9
Calculate the two cross rates
between yen and Australian dollars.
Yen
x U.S. Dollars
U.S. Dollar
A. Dollar
= 111.11 x 0.650
= 72.22 yen/A. dollar.
Cross rate =
Cross rate = A. Dollars x U.S. Dollars
U.S. Dollar
Yen
= 1.5385 x 0.009
= 0.0138 A. dollars/yen.
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16 - 10
Note:
The two cross rates are
reciprocals of one another.
They can be calculated by dividing
either the direct or indirect
quotations.
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16 - 11
A firm can produce a liter of
orange juice and ship it to Japan for
$1.75. If the firm wants a 50% markup
on the product, what should the
juice sell for in Japan?
Price = (1.75)(1.50)(111.11)
= 291.66 yen.
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16 - 12
Now the firm begins producing the
orange juice in Japan. The product
costs 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?
250 yen = 250(0.0138) = 3.45 A. dollars.
6 – 3.45 = 2.55 Australian dollar profit.
1.5385 A. dollars = 1 U.S. dollar.
Dollar profit = 2.55/1.5385 = $1.66.
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16 - 13
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.
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16 - 14
Describe the current and former
international monetary systems.
The current system is a floating rate
system.
Prior to 1971, a fixed exchange rate
system was in effect.
The U.S. dollar was tied to gold.
Other currencies were tied to the
dollar.
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16 - 15
The European Monetary Union
In 2002, the full implementation of the
“euro” is expected to be complete.
The national currencies of the 12
participating countries will be phased
out in favor of the “euro.” The newly
formed European Central Bank will
control the monetary policy of the
EMU.
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16 - 16
The 12 Member Nations of the
European Monetary Union
Austria
Germany
Luxembourg
Belgium
Greece
Netherlands
Finland
Ireland
Portugal
France
Italy
Spain
European Union countries not in the EMU:
Britain Sweden Denmark
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16 - 17
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.
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16 - 18
What problems arise when a firm
operates in a country whose
currency is not convertible?
It becomes very difficult for multinational 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.
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16 - 19
What is the difference between
spot rates and forward rates?
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.
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16 - 20
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
spot/forward rate relationship is
relative interest rates.
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16 - 21
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.
ft
1 + kh .
e0 = 1 + kf
ft = t-period forward exchange rate
e0 = today’s spot rate
kh = periodic interest rate in the home country
kf = periodic interest rate in the foreign country
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16 - 22
Assume 1 yen = $0.0095 in 30-day
forward market and kNom for 30-day
risk-free securities in Japan and U.S.
= 4%. Does interest rate parity hold?
No.
ft = $0.0095
kh = 4%/12 = 0.333%
kf = 4%/12 = 0.333%
(More...)
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16 - 23
ft
1  kh

e0 1  k f
$0.0095 1.0033

e0
1.0033
$0.0095
 1.
e0
Therefore, if interest rate parity holds
then e0 = $0.0095. However, we were
given earlier that e0 = $0.0090.
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16 - 24
What security offers highest return?
Japanese security.
1. Convert $1,000 to yen in spot market. $1,000
x 111.111 = 111,111 yen.
2. Invest 111,111 yen in 30-day Japanese
security. In 30 days receive 111,111 yen x
1.00333 = 111,481 yen.
3. Agree today to exchange 111,481 yen 30 days
from now at forward rate.
111,481/105.2632 = $1,059.07.
4. 30-day return = $59.07/$1,000 = 5.907%,
nominal annual return = 12 x 5.907% =
70.88%.
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16 - 25
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.
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16 - 26
If grapefruit juice costs $2.00/liter in
U.S. and PPP holds, what is the price
of grapefruit juice in Australia?
PPP = e0 = Ph/Pf
$0.6500 = $2.00/Pf
Pf = $2.00/$0.6500
= 3.0769 Australian dollars.
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16 - 27
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.
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16 - 28
Describe the 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
than the one in whose currency the
bonds are denominated.
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16 - 29
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
previously thought.
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16 - 30
What is the impact of multinational
operations on each of the
following topics?
Cash Management
Distances are greater.
Access to more markets for loans
and for temporary investments.
Cash is often denominated in
different currencies.
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16 - 31
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 account.
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16 - 32
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.
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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.
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