Slide Financial Management - Chapter 19 pdf

19-1
CHAPTER 19
Multinational Financial
Management
 Multinational vs. domestic financial
management
 Exchange rates and trading in foreign
exchange
 International money and capital markets
19-2
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.
19-3
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.

19-4
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.
19-5
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.
19-6
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.
19-7
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.
19-8
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.
 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:
0.0138 A. Dollars / Yen
19-9
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
19-10
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
19-11
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.
19-12
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.
19-13
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
19-14
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.
19-15
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.
19-16
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.
19-17
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.
19-18
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.
country foreign in rateinterest periodic k
country home in rateinterest periodic k
rate exchangespot stoday' e
rate exchange forward period-t f
k 1
k1

e
f

f
h
0
t
f

h
0
t
=
=
=
=
+
+
=
19-19
Evaluating interest rate parity
 Suppose one yen buys $0.0095 in the 30-
day forward exchange market and k
NOM
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
f
= 4% / 12 = 0.333%
19-20
Does interest rate parity hold?
 Therefore, for interest rate parity to hold,

e
0
must equal $0.0095, but we were given
earlier that e
0
= $0.0090.
1
e
0.0095
1.0033
1.0033

e
0.0095
0
0
=
=
19-21
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%.
19-22
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.
P
h
= P
f
(e
0
)
-OR-
e
0
= P
h
/P
f
19-23
If grapefruit juice costs $2.00 per liter
in the U.S. and PPP holds, what is the
price of grapefruit juice in Australia?
e
0
= P

h
/P
f
$0.6500 = $2.00/P
f
P
f
= $2.00/$0.6500
= 3.0769 Australian dollars.
19-24
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.
19-25
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.