© 2001 Prentice Hall 20-1
International Businessby
Daniels and Radebaugh
Chapter 20The MultinationalFinance Function
© 2001 Prentice Hall 20-2
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
© 2001 Prentice Hall 20-3
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
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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
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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
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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
© 2001 Prentice Hall 20-7
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
© 2001 Prentice Hall 20-8
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
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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
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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
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19863.60%
96.40%1994
12.70%
87.30%1998
93.10%
6.90%
Emerging markets
Developed markets
Growth of Emerging Stock Markets
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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
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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
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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
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Dividends,royalties,and fees
FrenchSubsidiary
BrazilianSubsidiary
ParentCompany
Loans
Extensions ofaccounts payable
Invests moreequity capital
Loans Guaranteeloans
Internal Sources of Working Capital for MNEs
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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
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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
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GermanSubsidiary
$150,000
$200,000 $200,000
$100,000 United KingdomSubsidiary
FrenchSubsidiary
$50,000
$50,000
$200,000
ItalianSubsidiary
Multilateral Cash Flows
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FrenchSubsidiary
ItalianSubsidiary
GermanSubsidiary
United KingdomSubsidiary
ClearingAccount
$100,000
$100,000$150,000
$150,000
Multilateral Netting
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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
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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
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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
© 2001 Prentice Hall 20-23
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
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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