MULTINATIONAL

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TOPIC 11
MULTINATIONAL FINANCIAL MANAGEMENT
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REASONS WHY COMPANIES
GO INTERNATIONAL
1. Growth opportunities may be better 2. Loca
tion of raw materials 3. May be seeking leading
knowledge or skills 4. Cheaper production costs
5. Avoid political and regulatory problems 6.
To diversify
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MAJOR FACTORS THAT DISTINGUISH
INTERNATIONAL FINANCIAL MANAGEMENT 1. Cash f
lows will be denominated in different
currencies 2. Economic and legal problems
3. Ability to communicate 4. Business val
ues may differ from one country to another
5. Markets may be less competitive than
the US market 6. Political risk may be a prob
lem 16-3
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EXCHANGE RATES EXCHANGE RATE The price of one
countrys currency expressed in terms of another
countrys currency. DIRECT QUOTE (American quo
te) How many dollars does it take to buy one un
it of a foreign currency? EXAMPLE The Austral
ian dollar is quoted at .7002.
This means you can buy one Australian dollar
with .7002 American dollars.
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INDIRECT QUOTE How many units of a foreign curren
cy can you get with 1 US dollar? EXAMPLE
How many Australian dollars can you get
with one US dollar? Suppose you decide that the
most you will spend for a hotel room is 35. Ho
w much would this be in Australian dollars?
35 / .7002 49.9857 Australian dollars
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CROSS RATES The exchange rate between two currenc
ies other
than US dollars.
EXAMPLE If the direct quotation between poun
ds and dollars is 1.5623 and the indirect quota
tion between euros and dollars is 1.1482 euros,
the cross rate between pounds and euros can be c
alculated as follows Dollars Euros Eu
ros Cross rate ---------- X ----------
---------- Pound Dollar Pound
1.5623 X 1.1482 1.7938
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FLOATING EXCHANGE RATES Exchange rates go up and
down according to supply and demand they are no
t fixed by the government. If the value of th
e US dollar appreciates against
another currency, it can buy more of the foreign
currency than before. If the US dollar deprecia
tes, it will buy fewer units of a foreign curren
cy. EXAMPLE If Japan consistently sells more
goods in the US than the US sells in Japan, Jap
anese firms will have trouble converting their U
S dollars into yen. The excess dollars offered
for sale in the currency markets will cause the
value of the dollar to fall compared to the valu
e of the yen. This will depreciate the dollar r
elative to the yen. 16-7
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THE CURRENT SITUATION (THE DISAPPEARING DOLLA
R) The US dollar has been the leading internati
onal currency for a long time. But it has falle
n more than 35 against the Euro in 3 years and
has been depreciating for a long time. We have
rampant government borrowing, furious consumer s
pending, and a huge current account deficit. At
some point other countries may decide that the
American dollar is no longer safe and they wil
l not want to hold a tremendous volume of our go
vernment securities. If they stop buying them,
the value of the dollar will continue to decline
. A depression could result.
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MAJOR FACTORS THAT AFFECT EXCHANGE RATES 1. I
nflation Countries with high inflation rat
es have currencies that are depreciating ag
ainst other currencies. And, the
currency of countries with less inflation
than the US will have their currency apprec
iate against the dollar. This is because c
urrency exchange rates tend to vary
inversely with their purchasing powers to
provide the same or similar purchasing powe
r in each country. 2. Interest rates In
vestment capital flows in the direction of higher
yield for a given level of risk.

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3. Balance of payments When a country sell
s (exports) more goods and services than it
buys (imports) it will have a
trade surplus. This will increase the demand
for that countrys currency. 4. Governme
nt policies Free trade agreements, direct
intervention in currency purchases or sal
es, etc.
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SPOT RATES AND FORWARD RATES SPOT RATE--Immediate
(within 2 days) delivery. FORWARD RATE The agr
eed price at which two currencies will be traded
(usually) in 30, 90, or 180 days.
EXAMPLE Assume a US company must pay a Japanes
e firm 600 million yen in 90 days. The current
spot rate is 120.87 yen per dollar. If the spot
rate does not change, the US company will pay t
he equivalent of 4.9640 million
(600 million yen divided by 120.87 yen per
dollar) in 90 days. If the spot rate falls
to 110 yen per dollar, the US company
will have to pay the equivalent of 5.4545
million. Hedging If the 90 day forward rate i
s 121 yen per dollar, the US company can enter i
nto a contract and agree to buy
600 million yen in 90 days at 121 yen per dollar
(which would cost 4.9587 million). 16-11
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PURCHASING POWER PARITY (THE LAW OF ONE PRICE)
The exchange rate should adjust so that identica
l goods cost the same in different countries. A
ssumes there are no transportation or transactio
n costs and no import restrictions. EXAMPLE
If golf clubs cost 300 in the US and 200 Euros
in Europe the exchange rate should be PUS
Price in US -------- ----------------
------ or 300/200 1.500 P E Price in E
urope Arbitrage Suppose the clubs could be bo
ught in the US for 280. Importers/exporters co
uld buy the clubs in the US, sell them in Europe
for 200 Euro, exchange the Euros for
300 and make a 20 profit. 16-12
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INTEREST RATE PARITY
Investors should expect to earn the same return
in
all countries after adjusting for risk.
Forward exchange rate (1 rh)
--------------------------- ---------
Spot exchange rate (1 rf) Example US 6
month T-bills 7 (nominal)
Japanese 6 months bond 5.5 (nominal)
Spot exchange market 1 yen equals 0.009
What should be the 6 month forward exchange
rate? Solution 7 / 2 3.5 and 5.5 /2 2.7
5 Forward exchange rate 1.035 ----------
------------------ -------- 0.009
1.0275 The 6 month forward exchange rate is 1 yen
0.00907 16-13
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• OTHER FEATURES OF
• INTERNATIONAL FINANCE
• Eurodollar A US dollar deposited in a bank
  outside
  
• the US.
• EurobondA bond sold in a country other than the
• one in whose currency the bond is denominated.
• American Depository Receipts (ADRs)Certificates
• representing ownership in foreign stock held in
  trust.
  
• Many multinational companies issue new
• simultaneously in multiple companies and many
• companies have their stocks traded in many
  countries.
  
• Estimation of cash flows for capital budgeting is
  more
  
• complex. Foreign countries may limit or
  prohibit the
  
• amount of cash that may be sent back to the US.
• Country ratings for political risk are
  available.
  
• Countries have very different capital
  structures.
  
• Accounting practices may vary considerably.
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