Business finance ch 19 multinational financial management

Consider the following exchange rates US $ to buy 1 unitJapanese yen 0.009 Australian dollar 0.650  Are these currency prices direct or indirect quotations?.  Since they are prices of

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

6. To diversify.

What factors distinguish

multinational financial management from domestic financial

Consider the following

exchange rates

US $ to buy 1 unitJapanese 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

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?

terms of an indirect quotation.

usually in terms of a direct quotation.

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

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

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

is a floating rate 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

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 national companies to conduct

multi-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

What is interest rate

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

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

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 bonds are denominated

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 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 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.