Business finance ch 19 multinational financial management

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.
2.
3.
4.
5.
6.

To seek new markets.
To seek raw materials.
To seek new technology.
To seek production efficiency.
To avoid political and regulatory
hurdles.
To diversify.
19-3


What factors distinguish
multinational financial management

from domestic financial
management?
1. Different currency denominations.
2.
3.
4.
5.
6.

Economic and legal ramifications.
Language differences.
Cultural differences.
Role of governments.
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 / US Dollar) x (US Dollar /
= 111.11 x 0.650

= 72.22 Yen / A. Dollar
The inverse of this cross rate yields:
0.0138 A. Dollars / Yen

A. Dollar)

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
Belgium
Finland
France
German
y
Greece








Ireland
Italy
Luxembourg
Netherlands
Portugal
Spain

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 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.

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)
-ORe0 = 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