© 2001 prentice hall20-1 international business by daniels and radebaugh chapter 20 the...

© 2001 Prentice Hall 20-1

International Businessby

Daniels and Radebaugh

Chapter 20The MultinationalFinance Function


ObjectivesTo describe the multinational finance function and how it fits

in the MNE’s organization structureTo show how companies can acquire outside funds for normal

operations and expansionTo discuss the major internal sources of funds available to the

MNE and show how these funds are managed globallyTo explain how companies protect against the major financial

risks of inflation and exchange-rate movementTo highlight some of the financial aspects of the investment

decision


OPERATIONS

OBJECTIVES

STRATEGY

EXTERNAL INFLUENCES

COMPETITIVE ENVIRONMENT

PHYSICAL AND SOCIETAL FACTORS

Functions• Marketing• Exporting and importing• Global manufacturing• Supply chain management• Accounting• FINANCE• Human resources

Modes

MEANSOverlayingAlternatives

Finance in International Business


IntroductionMNEs need access to capital

• Finance is integral to firm’s operating strategies• Concern with access to capital in local and global

markets

Finance and Treasury Functions in the Internalization ProcessChief Financial Officer (CFO)—vice president of finance

• Responsible for controllership and treasury functions

• Acquires financial resources—generates funds from internal and external sources

• Allocates financial resources—increases stockholders’ wealth by allocating funds to different projects and investment opportunities

• Manages cash flows


V P , S a les /M arke tin g

C on tro lle r

C ash M an ag er C red it M an ag er

E xp os u reM an ag em en t

B u d g e tP lan n in g

B id S u p p ort P rocess F ore ig nC u rren cy

G lob a l F in an ce C ap ita lE xp en d itu re

F in an c ia lP lan n in g

Treasu re r

V P , F in an ce V P , O p era tion s V P , R & D

P res id en t an d C O O

C h a irm an an d C E O

B oard o f D irec to rs

Location of Treasury Function in the Corporate Organizational Structure


Global Debt MarketsCompanies follow financing trends in their own country and

industry• Leverage—degree to which a firm funds the growth of the

business by debt– interest on debt is tax deductible

• Equity capital—stocks or shares– dividends paid to investors are not deductible

• Choice of debt versus equity affected by a variety of factors

Companies can use local and international debt markets to raise funds

• Subsidiaries or foreign companies may find it easier to obtain credit than local companies

– back-to-back loan—made between a firm in country A with a subsidiary in country B and a bank in country B with a branch in country A


Global Debt Markets (cont.)Eurocurrencies—any currency that is banked outside of its

country of origin• Major sources of Eurocurrencies include:

– foreign governments or individuals who want to hold dollars outside of the U.S.

– MNEs with excess cash– European banks with excess foreign currency– countries with large balance-of-trade surpluses held

as reserves• Characteristics of Eurocurrency market

– completely unregulated offshore market– both short and medium term– Eurocurrency deposits yield higher interest– Eurocurrency loans tend to be cheaper

» London Inter-Bank Offered Rate (LIBOR)—interest rate that banks charge each other on Eurocurrency loans


Global Debt Markets (cont.)International bond market—an attractive place to borrow

money that fills an important niche in financing• Tends to be less expensive than local markets• Foreign bonds—sold outside of the borrower’s country

but in the currency of the country of issue• Eurobonds—underwritten by banking syndicate and sold

in countries other than the one in whose currency the bond is denominated

– sold in several financial centers– some have currency options allowing the creditor to

demand repayment in one of several currencies• Global bond—combination of domestic bond and

Eurobond– registered in each national market


Equity Securities and the EuromarketEquity securities—investor takes an ownership position in

return for shares of stock, the promises of capital gain, and dividends

• Many companies are using private placements to raise equity capital

– venture capitalist—invests money in a new venture in exchange for stock

• Equity-capital markets (stock markets)—listing may be on home country or foreign exchange

– market capitalization—total number of shares of stock listed times the market price per share

» in part the increase has resulted from privatization in emerging markets and global economic growth


Equity Securities and the Euromarket (cont.)Euroequity market—market for shares sold outside the issuing

company’s home country• Firms often list on only one big foreign exchange

– e.g., 379 foreign companies listed on the New York Stock Exchange

• Companies with investments in several countries may list on different exchanges

• American Depositary Receipt (ADR)—a negotiable certificate issued by a U.S. bank and representing shares of stock of a foreign company

• Global Depositary Receipts and European Depositary Receipts—other markets for Euroequities

• Global share offering—simultaneous offering of actual shares on different exchanges

• Electronic trading of stocks is a major source of competition for stock exchanges


19863.60%

96.40%1994

12.70%

87.30%1998

93.10%

6.90%

Emerging markets

Developed markets

Growth of Emerging Stock Markets


Offshore Financial CentersCities or countries that engage in a variety of financial

transactions• Provide significant tax advantages• Centers for the Eurocurrency market• Markets are less regulated than domestic markets• Provide an alternative, cheaper source of funding• May be:

– operational centers—extensive banking activities involving short-term financial transactions

– booking centers—little banking activity» financial transactions recorded to take advantage

of secrecy and low tax rates• Good locations for establishing financial subsidiaries


Large foreign-currency marketfor loans/deposits

OffshoreFinancial

Center

Goodcommunications

Pass-through forinternational

loan funds

Efficient andexperienced

financialcommunity

Favorableregulatory

climate

Economic andpolitical stability

Large net supplierof funds to worldfinancial markets

Good supportiveservices

Characteristics of Offshore Financial Centers


Internal Sources of FundsFunds—working capital, i.e., the difference between current

assets and current liabilities• Used to expand operations or satisfy demands for capital

Sources of funds—MNEs have more complex arrangements due to the number of subsidiaries and the diverse environments in which they operate

• Loans• Dividends• Intercompany receivables and payables• Investments through equity capital

Funds may flow from subsidiaries to parent or vice versa


Dividends,royalties,and fees

FrenchSubsidiary

BrazilianSubsidiary

ParentCompany

Loans

Extensions ofaccounts payable

Invests moreequity capital

Loans Guaranteeloans

Internal Sources of Working Capital for MNEs


Internal Sources of Funds (cont.)Global cash management—requires the collection and payment

of cash resulting from the normal operational cycle • Generates and invests cash through dealings with

financial institutions• Assesses a company’s cash needs using budgets and

forecasts• Involves decisions about the degree of centralization of

cash– transfers of cash may be in the form of dividends,

royalties, management fees, and repayment of loans– governments concerned about the outflow of foreign

exchange may curtail cash transfers abroad


Internal Sources of Funds (cont.)Multilateral netting—company establishes one center to handle

all internal cash, funds, and financial transactions• Enables companies to reduce the amount of cash flow

and move cash more quickly and efficiently• Advantages include:

– optimizing the use of excess cash– reducing interest expenses and maximizing interest

yields– reducing costly foreign exchange, swap transactions,

and intercompany transfers– minimizing administrative paperwork– centralizing and speeding information

• Multilateral cash flows in the absence of netting require each subsidiary to settle intercompany obligations

– not as advantageous as netting


GermanSubsidiary

$150,000

$200,000 $200,000

$100,000 United KingdomSubsidiary

FrenchSubsidiary

$50,000

$50,000

$200,000

ItalianSubsidiary

Multilateral Cash Flows


FrenchSubsidiary

ItalianSubsidiary

GermanSubsidiary

United KingdomSubsidiary

ClearingAccount

$100,000

$100,000$150,000

$150,000

Multilateral Netting


Foreign-Exchange Risk ManagementTranslation exposure—arises because, as the exchange

rate changes, the dollar value of the exposed asset or liability changes

• Combined effect of the exchange-rate change is either a net gain or loss

– does not represent an actual cash flow effect because the cash is only translated into dollars, not converted into dollars

Transaction exposure—arises because the receivable or payable changes in value as the exchange rate changes

Economic exposure (operating exposure)—potential for change in expected cash flows that arise from the:

• Pricing of products • Sourcing and cost of inputs• Location of investments• Competitive position of the company in markets


Exposure-Management StrategyDefining and measuring exposure

• MNE must forecast the degree of exposure in each major currency in which it operates

– exchange-rate movements are forecasted using in-house or external experts

Reporting system—substantial participation from foreign operations combined with central control

• Foreign input important to ensure forecasting effectiveness

• Central control of exposure protects resources more efficiently

– defines and controls overall company exposure• MNEs should devise uniform reporting system for

its subsidiaries• Time periods of reports vary• Final reporting should be at corporate level


Exposure-Management Strategy (cont.)Centralized policy—top management should determine hedging

policy• Corporate treasurer should be able to design and

implement a cost-effective program• Some decisions must be decentralized in order to react

quickly to changes in the international monetary environment

• Some companies run hedging operations as profit centers and nurture in-house trading desks

Formulating hedging strategies—safest position has exposed assets equal to exposed liabilities

• Operational strategies—involve adjusting the flow of money and resources to reduce foreign-exchange risk

– using local debt to balance local assets– taking advantage of leads and lags for intercompany

payments


Exposure-Management Strategy (cont.)Formulating hedging strategies (cont.)

• Contractual arrangements– forward contract—establishes a fixed exchange rate

for future transactions– foreign-currency option—purchaser has the right, but

not the obligation, to buy or sell a certain amount of foreign currency at a set exchange rate within a specified period of time

– more flexible than forward contract


Capital Budgeting Decision in an International ContextParent company needs to compare the net present value or

internal rate of return of a foreign project with that of its other projects and with that of others available

Unique aspects of capital budgeting for foreign projects• Parent cash flows must be distinguished from project

cash flows• Remittance of funds to the parent affected by differing

tax systems, and legal and political constraints on movement of funds

• Differing rates of inflation must be anticipated• Parent must consider possible changes in exchange rates• Must evaluate political risk in foreign market• Terminal value is difficult to estimate

© 2001 prentice hall20-1 international business by daniels and radebaugh chapter 20 the...

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