MULTINATIONAL FINANCIAL
MANAGEMENT
By Sharlaine Mae G. Andal
What is a multinational corporation?
• A corporation that operates in two or m
ore countries.
• Global Corporation/ International Corp
oration
Why do companies go global?
• To seek production efficiency.
• To avoid political, trade, and regulatory hurdle
s.
• To broaden their markets.
• To seek raw materials and new technology.
• To protect processes and products.
• To diversify.
• To retain customers.
What factors distinguish multinational
financial management from domestic
financial management?
• Different currency denominations.
• Political risk.
• Economic and legal ramifications.
• Role of governments.
• Language and cultural differences.
International Monetary System
• The framework within which exchange rates ar
e determined; and it ties global currency, mone
y, capital, real estate, commodity, and real ass
et markets into a network of institutions and ins
truments regulated by intergovernmental agree
ments and driven by each country’s unique poli
tical and economic objectives.
International Monetary Terminology
• Exchange Rate
– Direct quotation
– Indirect quotation
• Spot Exchange
• Forward Exchange
• Fixed Exchange Rate
• Floating or Flexible Exchange rate
• Devaluation or revaluation of a currency
Consider the following Exchange R
ates
US $ to buy 1 unit
Japanese yen 0.009
Australian dollar 0.650
Philippine Peso 0.020
Are these currency prices direct
or indirect quotations?
• Are you more likely to observe
direct or indirect quotations?
– Most exchange rates are stated in
terms of an indirect quotation.
– Except the British pound, which is
usually in terms of a direct quotation.
Calculate the indirect quotations
for yen and Australian dollar
# of units of foreign
currency per US $
Japanese yen111.11
Australian dollar1.5385
Philippine Peso 50.00
• Simply find the inverse of the direct
quotations.
What is 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
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-up
on date in the future.
When is the forward rate at a premium to th
e 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 interest rates.
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.
ft 1 kh
e0 1 k f
f t 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
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?
• Interest rate parity holds that investors should expect
to earn the same return in all countries after adjusting for
risk. 0.0095 1.0033
e0 1.0033
0.0095
1
e0
• Therefore, for interest rate parity to hold, e0 must
equal $0.0095, but we were given earlier that
e0 = $0.0090.
What is purchasing power parity?
• 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, s
o the effective interest cost increases
over the life of the loan.
International money and capital
markets
• Eurocredits/Eurodollar
– a source of dollars outside the U.S.
• International bonds
– Foreign bonds – sold by foreign borrower, but deno
minated in the currency of the country of issue.
– Eurobonds – sold in country other than the one in w
hose currency the bonds are denominated.
Impact of multinational operations
• Cash management
– Distances are greater.
– Access to more markets for loan
s 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. taxe
s.
– Foreign projects are subject to
political risk.
– Funds repatriated must be converted to U.S. do
llars, so exchange rate risk must be taken into
account.
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.
– Some factors to consider are shipping times,
carrying costs, taxes, import duties, and exchange rates.
