This chapter emphasizes the decisions involved in the manage¬ment of cash by an MNC. The additional opportunities and risks of cash management for an MNC versus a domestic firm should be stressed. There are actually three key components of the chapter. The first is distinguishing between subsidiary control over excess cash versus centralized control.
Trang 1International Cash Management 28
Lecture
Trang 221 - 2
Chapter Objectives
To explain the difference in
analyzing cash flows from a subsidiary
perspective versus a parent perspective;
To explain the various techniques used to
optimize cash flows;
To explain common complications in
optimizing cash flows; and
To explain the potential benefits and risks
of foreign investments.
Trang 3in Optimizing Cash Flows
Company-related characteristics
¤ When a subsidiary delays its payments to
the other subsidiaries, the other
subsidiaries may be forced to borrow until
the payments arrive
Government restrictions
¤ Some governments may prohibit the use of
a netting system, or periodically prevent
cash from leaving the country
Trang 421 - 4
Characteristics of banking systems
¤ The abilities of banks to facilitate cash
transfers for MNCs may vary among
countries
¤ The banking systems in different countries
usually differ too
Complications
in Optimizing Cash Flows
Trang 5Investing Excess Cash
• Excess funds can be invested in domestic
or foreign short-term securities, such as
Eurocurrency deposits, Treasury bills, and
commercial papers.
• Sometimes, foreign short-term securities
have higher interest rates However, firms
must also account for the possible
exchange rate movements.
Trang 621 - 6
Short-Term Interest Rates
as of February 2004
Trang 7Centralized Cash Management
• Centralized cash management allows for
more efficient usage of funds and possibly
higher returns.
• When multiple currencies are involved, a
separate pool may be formed for each
currency Funds can also be invested in
securities that are denominated in the
currencies needed in the future.
Investing Excess Cash
Trang 821 - 8
• Given the current online technology,
MNCs should be able to efficiently create a
multinational communications network
among their subsidiaries to ensure that
information about their cash positions is
continually updated.
Investing Excess Cash
Centralized Cash Management
Trang 9Determining the Effective Yield
• The effective yield on foreign investments
r = (1 + if )(1 + ef ) – 1
where if = the quoted interest rate on the
investment
ef = the % in the spot rate
Investing Excess Cash
• If the foreign currency depreciates over
the investment period, the effective yield
Trang 1021 - 10
Trang 11Implications of Interest Rate Parity (IRP)
• A foreign currency with a high interest
rate will normally exhibit a forward
discount that reflects the differential
between its interest rate and the investor’s home interest rate.
• However, short-term foreign investing on
an uncovered basis may still result in a
higher effective yield.
Investing Excess Cash
Trang 1221 - 12
Use of the Forward Rate as a Forecast
• If IRP exists, the forward rate can be used
as a break-even point to assess the
short-term investment decision.
• The effective yield will be higher than the
domestic yield if the spot rate at maturity
is more than the forward rate at the time
the investment was undertaken.
Investing Excess Cash
Trang 13Use of the Forward Rate as a Forecast
Trang 1421 - 14
Trang 15Use of Exchange Rate Forecasts
• Given an exchange rate forecast, the
expected effective yield of a foreign
investment can be computed, and then
compared with the local investment yield.
• It may be useful to use probability
distributions instead of point estimates, or
to compute the break-even exchange rate that will equate foreign and local yields.
Investing Excess Cash
Trang 1621 - 16
Deriving the Value of ef that Equates Foreign
and Domestic Yields
r = (1 + if )(1 + ef ) – 1
ef = (1 + r ) – 1
(1 + if )
• r = 11%, if = 14% breakeven ef = -2.63%.
If the foreign currency depreciates by less
than 2.63%, the foreign currency deposit
will be more rewarding.
Investing Excess Cash
Trang 17Use of Probability Distributions
Trang 1821 - 18
Trang 19Probability Distribution of Effective Yield
Trang 2021 - 20
Diversifying Cash Across Currencies
• If an MNC is not sure of how exchange
rates will change over time, it may prefer
to diversify its cash among securities that
are denominated in different currencies
• The degree to which such a portfolio will
reduce risk depends on the correlations
among the currencies.
Investing Excess Cash
Trang 21Use of Dynamic Hedging to Manage Cash
• Dynamic hedging refers to the strategy of
hedging when the currencies held are
expected to depreciate, and not hedging
when they are expected to appreciate.
• The overall performance is dependent on
the firm’s ability to accurately forecast the
direction of exchange rate movements.
Investing Excess Cash
Trang 2221 - 22
• Source: Adopted from
South-Western/Thomson Learning © 2006