CHAPTER 19

Multinational Financial
Management

 Multinational vs. domestic financial

management
 Exchange rates and trading in
foreign exchange
 International money and capital
markets
19-1
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
corporation does
business in.
19-2
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.
19-3
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.
19-4
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

currencies expressed in dollars, they

are direct quotations.

19-5
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
usually in terms of a direct quotation.
19-6
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.

19-7
 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 / USDollar ) x (USDollar / A. Dollar )
= 111.11 x 0.650
= 72.22 Yen / A. Dollar
 The inverse of this cross rate yields:
0.0138 A. Dollars / Yen

19-8
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?

Price = (1.75)(1.50)(111.11)
= 291.66 yen

19-9
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
 U.S. dollar profit = 2.55 / 1.5385 = $1.66

19-10
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.
19-11
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.

19-12
 Member nations of the
EMU
 Austria  Ireland
 Belgium  Italy
 Finland  Luxembourg
 France  Netherlands
 German  Portugal
y  Spain
 Greece
 Notable European Union
countries not in the EMU:
 Britain, Sweden, and Denmark

19-13
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.

19-14
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.

19-15
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
buy currency at some agreed-
upon date in the future.

19-16
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.
19-17
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 - periodforwardexchangerate
e0 = today's spotexchangerate
kh = periodicinterestratein homecountry
kf = periodicinterestratein foreigncountry
19-18
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%.
 ft = 0.0095
 kh = 4% / 12 = 0.333%
 kf = 4% / 12 = 0.333%

19-19
Does interest rate parity
hold?
0.0095 1.0033
=
e0 1.0033

0.0095
=1
e0

 Therefore, for interest rate parity to

hold, e0 must equal $0.0095, but we
were given earlier that e0 = $0.0090.

19-20
 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.
 30-day return = $59.07/$1,000 = 5.907%, nominal
annual return = 12 x 5.907% = 70.88%.

19-21
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

19-22
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.

19-23
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.

19-24
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.

19-25
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.
19-26
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.

19-27
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 account.

19-28
 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, carrying
costs, taxes, import duties, and exchange rates.

19-29