Slide Financial Management - Chapter 19 pdf

Calculate the indirect quotations for yen and Australian dollar# of units of foreign currency per US $ Australian dollar 1.5385 „ Simply find the inverse of the direct quotations... Wha

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.

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

To diversify

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

Consider the following

„ Since they are prices of foreign

currencies expressed in dollars, they are

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

Calculate the indirect quotations for yen and Australian dollar

# of units of foreign currency per US $

Australian dollar 1.5385

„ Simply find the inverse of the direct

quotations.

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

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

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

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

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

Member nations of the EMU

„ Notable European Union

countries not in the EMU:

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

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

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

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

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 rate interest

periodic k

country home

in rate interest

periodic k

rate exchange

spot s

today' e

rate exchange

forward period

t f

-k 1

k

1 e

f

=

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%

Does interest rate parity hold?

„ Therefore, for interest rate parity to hold,

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

1 e

0.0095

1.0033

1.0033 e

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 =

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

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

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.

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

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

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.