MULTINATIONAL FINANCIAL

MANAGEMENT

Multinational or Global Corporation

A firm that operates in an integrated fashion
in a number of (two or more) countries.
Decision making may be centralized in the
home country or decentralized across the
countries the corporation does business in.

Reasons why companies expand into

other countries

To broaden their markets (Seek new markets)

To seek raw materials
Vertically Integrated
Investment
To seek new technology
To seek production efficiency

Reasons why companies expand into

other countries
To avoid political, trade, and regulatory
hurdles
To diversify
To take advantage of specialized skills
To protect processes and products
To retain customers

Cost Migration Opportunities

Regional trends in cost migration

Going global
Becomes essential to effectively compete
especially with the advent of globalization
Used to be a competitive advantage before,
but now, it appears to be an inevitable move
especially for market leaders.

Major factors that complicate financial

management in multinational firms

Different currency denominations

Economic and legal ramifications
Language differences
Cultural differences
Role of governments
Political risks

Monetary System
Local (National) Monetary System and Authority
Each nation has a monetary system and authority.
Task is to:
Hold down inflation
Promote economic growth (raise living standards)

For the US, the local monetary authority is the Federal

Reserve.
For the Philippines, the local monetary authority is the BSP.

International Monetary System

Must be in place for smoothen trade and facilitate payments
between nations
May be fixed or float

International Monetary System

A system designed to facilitate payments between
nations when they are engaging in trade, thus, it is the
framework within which exchange rates are
determined.
It is the blueprint for international trade and capital
flows.
Regulated by intergovernmental agreements and driven
by each countrys unique political and economic
objectives.
Facilitates international trade, cross border investment
and the reallocation of capital between nations.

International Monetary Terminology

Exchange Rate
Spot exchange rate
Forward exchange rate
Fixed exchange rate
Floating or flexible exchange rate
Devaluation of Currency
Applicable for Fixed
Currencies
Revaluation of Currency
Depreciation of Currency
Applicable for Floating
Currencies
Appreciation of Currency

International Monetary System

End of WWII August 1971: Fixed exchange rate system (by
IMF)
Fixed exchange rate system
Also known as pegged exchange rate
A type of exchange rate regime wherein a currencys value is
matched to the value of another single currency or to a basket of
other currencies , or to another measure of value, such as gold.
Done by buying and selling own currency in the open market (have
huge foreign reserves) or making it illegal to trade currency at any
other rate (may lead to black market, however it may be successful
due to government monopolies over all money conversion)
Eg: China RMB (pegged to basket of currencies dollar, euro, Japanese yen,
Korean won, Singapore dollar, sterling, Malaysian ringgit, Russian rouble,
Australian dollar, Thai baht and Canadian dollar.)

International Monetary System

The current international monetary system is the Floating
Exchange Rate System
Floating Exchange Rate System
A system under which exchange rates are not fixed by government
policy but are allowed to float up or down in accordance with supply
and demand.
May cause exchange rate fluctuations and CB of each country needs
to intervene to smoothen out these fluctuations.
Results to Exchange Rate Risk

Broad Groups of Currency Regimes:

Floating Rates
Freely Floating Determined by supply and demand without
significant government intervention.

Managed Floating Significant government intervention in the

manipulation of the currencys supply and demand.

Fixed Rates
No local currency No local currency of its own and uses the
currency of other countries. It surrenders the ability to use exchange
rate to tinker with its economy.

Currency board arrangement A country has local currency

but commits to exchange it for a specified foreign money unit at a
fixed exchange rate.

Fixed-peg arrangement A country locks its currency to a

specific currency or basket of currencies at a fixed exchange rate.

Exchange Rates
Exchange rate the number of units of a given currency
that can be purchased for one unit of another currency
Direct Quotation Number of domestic currency
required to purchase one unit of foreign currency (FXY
expressed in DXY) eg: 1 Sgd = 32 Php
Indirect Quotation Number of units of foreign
currency that can be purchased for one unit of
domestic currency (DXY expressed in FXY) eg: 1 Php =
0.03125 Sgd
Direct quotation is the reciprocal of indirect quotation.

Consider the following exchange rates:

Japanese yen
Australian dollar

U.S. $ to buy
1 Unit
0.009
0.650

Assuming that domestic country is the US, are these

currency prices direct or indirect quotations?
Since they are prices of foreign currencies
expressed in dollars, they are direct quotations.

Calculate the indirect quotations

for yen and Australian dollars.

Japanese yen
Australian dollar

Yen:
A. Dollar:

# of Units of Foreign
Currency per U.S. $
111.11
1.5385

1/0.009 = 111.11.
1/0.650 = 1.5385.

Sample Problems on Simple Exchange

Rates
If one Swiss franc can purchase $0.71 U.S.
dollar, how many Swiss francs can one U.S.
dollar buy?
If one U.S. dollar buys 1.0279 euros, how
many dollars can you purchase for one euro?

Currency Cross Rates (European vs.

American terms)

Cross Rate (European Terms)

The exchange rate between any two
currencies.
They are actually calculated on the basis of
various currencies relative to the USD.

Calculate the two cross rates

between yen and Australian dollars.

Cross rate

Cross rate

Yen
U.S. Dollars
= U.S. Dollar x
A. Dollar
= 111.11 x 0.650
= 72.22 yen/A. dollar.

A. Dollars
U.S. Dollars
= U.S. Dollar x
Yen
= 1.5385 x 0.009
= 0.0138 A. dollars/yen.

Note:
The two cross rates are reciprocals of
one another.
They can be calculated by dividing either
the direct or indirect quotations.

Sample Problems for Cross Exchange Rates

A currency trader observes the following quotes in the spot
market:
122 Japanese yen
= 1 U.S. dollar
2.28 Swiss francs
= 1 British pound
1 British pound
= 1.6542 U.S. dollars
Given this information, what is the exchange rate between
the Swiss franc (SF) and the Japanese yen?

Sample Problems for Cross Exchange Rates

Currently, in the spot market $1 = 106.45 Japanese yen, 1
Japanese yen = 0.00966 euro, and 1 euro = 9.0606 Mexican
pesos. What is the exchange rate between the U.S. dollar
and the Mexican peso?
Suppose exchange rates between U.S. dollars and Swiss
francs is SF 1.6564 = $1.00 and the exchange rate between
the U.S. dollar and the euro is $1.00 = 1.0279 euros. What
is the cross rate of the Swiss franc to the euro?

Why is the USD the basis for cross rates?

Bretton Woods Agreement
Attempt to rebuild the international economic system after WW2
Done to regulate the international monetary system, BW planners
established IMF and IBRD (part of World Bank Group)
Each country should adopt a monetary policy that maintained the
exchange rate of its currency within a fixed value in terms of gold.
Gold was replaced by USD because there is inefficient supply of
gold (4.5 trillion) and there are also disadvantages and other
reasons (e.g. Soviet Union has a sizeable share of the worlds
known gold reserves, and it was later a Cold War Rival to US and
Western Europe)
The US Dollar acted as a store value as it was the strongest reserve
currency, and also it was pegged to gold.

Recall:
1 USD = 111.11 JPY
1 USD = 1.5385 AUD
Using Cross Rate:
1 JPY = 0.01385 AUD
1 AUD = 72.2220 JPY

1 JPY = 0.009 USD

1 AUD = 0.65 USD

Setting the appropriate price

A US 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

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 (or 2.55 x 0.65)

Sample Problems Exchange rates and

Profitability
The following exchange rates are quoted in the spot market:
$1 U.S. = 116.6 Japanese yen.
1 Canadian dollar = $0.66 U.S.
Crane Cola is a U.S. company with worldwide operations. The
company can produce a liter of cola in Canada at a cost of 0.45
Canadian dollars. The cola can be sold in Japan for 120 Japanese
yen. How much operating profit (measured in U.S. dollars) does
the company make on each liter of cola sold in the Japanese
market?

Sample Problems Exchange rates and

Profitability
Cypress Foods, a U.S. company, has a subsidiary that
produces lime juice in Brazil and sells it in Japan. The
exchange rates are such that 1 U.S. dollar equals 1.75
Brazilian real, and 1 U.S. dollar equals 120 Japanese yen.
Cypress spends 1.2 real to produce one unit of lime juice
and sells it for 100 Japanese yen. What is the profit in U.S.
dollars realized from each unit of lime juice sold?

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.
Risk inherent in a floating exchange rate system due
to exchange rate volatility.
This causes a companys consolidated cash flows to
fluctuate.

Other Terms:
Pegged Exchange Rate
Occurs when a country establishes a fixed exchange rate
with another major currency, consequently, values of
pegged currencies move together over time.
Usually done for smaller countries

Convertible Currency
A currency that may be readily exchanged for other
currencies
A currency is convertible when the issuing country
promises to redeem the currency at current market rates
These 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. (e.g. the communist
countries during the cold war. Hyperinflation,
e.g. in Germany after the two world wars.

Trading in Foreign Exchange

Difference between spot rates and forward
exchange rates:
Spot Rates
The effective exchange rate for a foreign currency for
delivery on (approximately) the current day.
The rates to buy currency for immediate delivery.

Forward Rates
An agreed-upon price at which two currencies will be
exchanged at some future date.
The rates to buy currency at some agreed-upon date in
the future.

Discount / Premium on Forward Rate

Discount on Forward Rate (SLD, FGD)
When spot rate < forward rate
If the local currency (USD) buys more units of foreign
currency in the forward market than in the spot market
Forward less valuable than spot because it takes more
units of a fxy to buy 1 USD in the future

Premium on Forward Rate (SGP, FLP)

When spot rate > forward rate
If the local currency (USD) buys more units of foreign
currency in the spot market than in the forward market
Forward more valuable than spot because it takes less
units of a fxy to buy 1 USD in the future

Illustrative Problem:
Forward Rates
Spot Rate 30 Days 60 Days 90 Days 180 Days
Philippine Peso 45.95
44.33
49.15
49.75
46.48

Which of the following statements is correct?

a. There is a premium on the 30 day forward rate on the
Philippine peso.
b. There is a discount on the 60 day forward rate on the
Philippine peso.
c. 1 USD is worth 45.95 Philippine pesos if traded
immediately.
d. All statements are correct.
e. None of the statements are correct.

Interest Rate Parity

Aka International Fisher Effect
Specifies that investors should expect to earn the same return
in all countries after adjusting for risk.
A theory that the interest rate differential between two
countries is equal to the differential between the forward
exchange rate and the spot exchange rate.
ft 1 k h

e0 1 k f
ft t - period forward exchange rate
e 0 today' s spot exchange rate
k h periodic interest rate in home country
k f periodic interest rate in foreign country

Interest Rate Parity Sample Problems:

In the spot market, 1 U.S. dollar can be exchanged for 121 Japanese yen.
In the 1-year forward market, 1 U.S. dollar can be exchanged for 125
Japanese yen. The 1-year, risk-free rate of interest is 5.2 percent in the
United States. If interest rate parity holds, what is the yield today on 1year, risk-free Japanese securities?
The nominal rate of interest on six-month, risk-free U.S. securities is 6
percent. Currently in the spot market, $1 U.S. = 104.84 Japanese yen. In
the six-month forward market, $1 U.S. = 104.84 Japanese yen. If
interest rate parity holds, what is the current nominal interest rate on
six-month, risk-free Japanese securities?
90-day investments in Great Britain have a 6 percent annualized return
and a 1.5 percent quarterly (90-day) return. In the U.S., 90-day
investments of similar risk have a 4 percent annualized return and a 1
percent quarterly (90-day) return. In the 90-day forward market, 1
British pound () = $1.65. If interest rate parity holds, what is the spot
exchange rate?

Discount / Premium on Currency

Currency is at Forward Premium
Domestic interest rate > Foreign interest rate

Currency is at Forward Discount

Domestic interest rate < Foreign interest rate

Purchasing Power Parity

Aka Law of One Price
The relationship in which the same products cost roughly the
same amount in different countries after taking into account
the exchange rate.
It 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
Ph = price of the good in the home country
Pf = price of the good in the foreign country
e0 = todays spot exchange rate

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.

Does PPP hold true?

Country
Argentina
Australia
Britain
Canada
China
Denmark
Egypt
Hong Kong
Hungary
India
Indonesia
Israel
Japan
Malaysia
Mexico
New Zealand
Philippines
Singapore
South Africa
South Korea
Switzerland
Taiwan
Thailand
Turkey
United States

Local Price
28
5.3
2.89
5.7
17.2
34.5
16.93
18.8
860
116.25
27939
17.5
370
7.63
49
5.9
163
4.7
25.5
4100
6.5
79
99
9.25
4.79

Dollar Exchange
8.61
1.23
0.66
1.23
6.21
6.42
7.35
7.75
271.39
61.62
12480
3.93
117.77
3.62
14.63
1.31
44.41
1.33
11.48
1083.3
0.86
31.49
32.61
2.33
1

Dollar Price
3.25
4.32
4.37
4.64
2.77
5.38
2.3
2.43
3.17
1.89
2.24
4.45
3.14
2.11
3.35
4.49
3.67
3.53
2.22
3.78
7.54
2.51
3.04
3.96
4.79

Dollar PPP
5.85
1.11
0.6
1.19
3.59
7.2
3.53
3.92
179.54
24.27
5832.78
3.65
77.24
1.59
10.23
1.23
34.03
0.98
5.32
855.95
1.36
16.49
20.67
1.93
1

Implied Dollar Valuation

-32.11
-9.84
-8.81
-3.14
-42.19
12.23
-51.91
-49.37
-33.84
-60.61
-53.26
-7.14
-34.41
-55.94
-30.07
-6.21
-23.37
-26.4
-53.62
-20.99
57.49
-47.63
-36.61
-17.24
0

PPP Illustrative Problem:

For your 19th birthday, your parents decided to buy you a
Bugatti Veyron. This is a German-made car from German
manufacturer, the Volkswagen Group. They asked you to
canvass prices from different car dealers all over the world to
determine the best deal. After making several inquiries, you
have come up with a list below:
COUNTRY
USA
China
Germany
Japan
Philippines

PRICE
USD 1,700,000
Yuan 12,000,000
Euro 1,150,000
Yen 140,000,000
Peso 80,000,000

 You have also come up with a cross rate list, as follows:

Currency
Codes/Names
EUR
JPY
USD
CNY
PHP

Euro
1
132.775
1.4513
9.9236
66.5126

Japanese
Yen
0.007533
1
0.010932
0.07475
0.501

US
Dollar
0.6891
91.4869
1
6.8376
45.8287

Chinese
Yuan
0.1011
13.4192
0.1467
1
6.7221

Philippine
Peso
0.01512
2.0079
0.02195
0.1501
1

Requirement 1: Ignoring all other costs such as import duties,

taxes, shipping costs, and holding costs, and assuming that cross
rates hold true, how much is the percentage overvaluation or
undervaluation if you decide to buy the car in Japan?
Requirement 2: Ignoring all other costs such as import duties,
taxes, shipping costs, and holding costs, and assuming that cross
rates hold true, in which country would you buy the car from in
order to get the best deal?

PPP Short Problems:

A telephone costs $100 in the United States.
The same telephone costs 150 Canadian
dollars. Assume that purchasing power parity
holds. What is the exchange rate between
U.S. and Canadian dollars?
A box of candy costs 28.80 Swiss francs (SF) in
Switzerland and $20 in the United States.
Assuming that purchasing power parity (PPP)
holds, what is the current exchange rate?

Inflation, Interest Rates, and Exchange Rates

What impact does relative inflation have on interest rates
and exchange rates?
Currencies with higher inflation than the US depreciates over
time against the USD. Currencies with lower inflation than the
US appreciate against the USD.
Lower inflation leads the Fed to lower interest rates.
Borrowing in low interest countries may appear attractive to
multinational firms. But, is it a good strategy?
As stated above, because 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.
Therefore, the lower interest rate could be more than offset by
losses from currency appreciation.

International Money and Capital Markets

International Credit Markets

Eurocredits

Floating-rate bank loans that are available in most major trading currencies and
that are tied to LIBOR. They tend to be issued for a fixed term with no early
repayment.
Eurodollar A source of dollars outside the US. USD deposited in a bank outside
US. Asian Dollar USD deposited in banks based in Asian countries.

International Bond Markets

Foreign Bonds sold by foreign borrower, but denominated in the currency of the
country of issue. Tend to be more regulated coz underwriter is subject to Phil. laws.
It is underwritten by investment banks from the same country. (China sells bonds to
Philippine companies and the bond is denominated in peso. Investment banks in the
Philippines underwrites the bonds. These bonds are from a different country). Eg:
Yankee, Bulldogs, Samurai Bonds, Matilda bonds
Eurobonds (external bonds) sold in the country other than the one in whose
currency the bonds are denominated. It is a bond issued in a currency other than
the currency of the country or market in which it is issued. It is underwritten by an
international syndicate. (China sells bonds to Philippine companies and the bond is
denominated in USD. An international syndicate underwrites the bonds. These
bonds cant be issued in the US)

International Money and Capital Markets

International Stock Markets
A Philippine firm may sell its stock in Japan to tap a larger
source of capital that the home country.
US firms may tap a foreign market to create an equity
market presence to accompany its operations in that
country.
Large multinational companies can issue new stock
simultaneously in multiple countries. This can create
arbitrage opportunities for investors.
American Depository Receipts (ADRs) certificates
representing ownership of foreign stock held in trust. They
are mostly traded on the OTC market but more are being
listed in stock exchanges.

Multinational Capital Budgeting

Involves more complex cash flow estimation and analysis.
Involves repatriation of earnings (the process of sending CFs
from foreign subsidiary back to the parent company), though
foreign government may restrict it.
Foreign subsidiaries or branches cash flows are converted to
the parent companys currency.
Must look at business climate refers to a countrys social,
political, and economic environment.
Involves higher risk, particularly:
Country risk the risk that arises from investing or doing business in a
particular country.
Exchange rate risk the risk that relates to what the basic CFs will be
worth in the parent companys home currency.
Political risk potential actions by a host government that would reduce
the value of a companys investment.

Current risk score

Current Sept Country name Current Economic Political Structural Credit rating Debt
rank
'10
score
(30%
(30%
(10%
(out of 10, indicators
weight) weight) weight) 10% wt)
(out of 10,
10% wt)

Access to
capital markets
(out of 10, 10%
wt)

Norway

93.44

90.40

92.97

84.10

10.00

10.00

10.00

Luxembourg 91.03

81.00

93.67

86.25

10.00

10.00

10.00

Switzerland

89.59

82.50

87.23

86.71

10.00

10.00

10.00

29

25

Korea South

72.28

65.75

67.86

69.13

7.29

10.00

8.00

39

60

Malaysia

64.75

60.80

60.63

65.40

6.25

8.04

7.50

40

36

China

63.55

66.88

48.47

52.41

7.71

8.73

7.25

42

45

Thailand

63.00

65.33

52.89

66.00

5.42

9.03

6.50

52

61

Indonesia

58.27

62.75

51.72

53.38

3.33

8.50

6.75

60

66

Sri Lanka

54.86

56.33

52.01

71.00

1.88

8.41

5.00

61

58

Philippines

54.46

52.67

50.08

57.50

2.92

8.23

6.75

62

102

Botswana

54.00

47.00

50.96

33.33

6.56

8.69

6.00

70

91

Bermuda

49.48

0.00

69.00

0.00

8.96

10.00

9.75

71

75

Vietnam

49.46

46.00

44.26

50.83

2.29

8.27

6.75

95

110

Nigeria

42.05

45.56

33.67

45.75

2.19

9.54

2.00

98

96

Belarus

39.84

43.75

34.38

27.81

1.88

8.73

3.00

99

101

Algeria

39.50

45.80

37.40

50.60

0.00

5.50

4.00

100

100

Mozambique 38.79

41.00

47.00

0.00

1.56

8.74

2.00

International Capital Structure

Companies capital structures vary among
countries.
Problems when comparing capital structures
among nations:
Reporting assets on a historical cost versus a
replacement cost basis.
Treating leased assets
Reporting pension plan liabilities
Capitalizing versus expensing R&D costs.

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.

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
account.

Impact of multinational operations

Credit management
Credit is more important, because commerce to lesserdeveloped 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.

Currency Appreciation
Suppose that 1 Kong Kong dollar could be
purchased in the foreign exchange market
today for $0.1290. if the Hong Kong dollar
appreciated 10% tomorrow against the dollar,
how many HKD would a US dollar buy
tomorrow?

Foreign Investment Analysis

After all foreign and US taxes, a US corporation expects to
receive 3 Singapore dollars of dividends per share from a
Singaporean subsidiary this year. The exchange rate at the
end of the year is expected to be $0.7062 per SGD, and the
SGD is expected to depreciate 5% against the dollar each
year for an indefinite period. The dividend (in SGD) is
expected to grow at 10% a year indefinitely. The parent US
corporation owns 10 million shares of the subsidiary. What
is the present value in dollars of its equity ownership of the
subsidiary? Assume a cost of equity capital of 15 percent
for the subsidiary.