1. International Businessby
Daniels and Radebaugh
Chapter 20
The Multinational
Finance Function
© 2001 Prentice Hall

2. Objectives
To describe the multinational finance function and how it fits in the MNE’s organization structure
To show how companies can acquire outside funds for normal operations and expansion
To discuss the major internal sources of funds available to the MNE and show how these funds are managed globally
To explain how companies protect against the major financial risks of inflation and exchange-rate movement
To highlight some of the financial aspects of the investment decision
© 2001 Prentice Hall

3. Finance in International Business
EXTERNAL INFLUENCES
COMPETITIVE
ENVIRONMENT
PHYSICAL AND
SOCIETAL FACTORS
OPERATIONS
OBJECTIVES
STRATEGY
MEANS
Overlaying
Alternatives
Modes
Functions
Marketing
Exporting and importing
Global manufacturing
Supply chain
management
Accounting
FINANCE
Human resources
© 2001 Prentice Hall

4. Finance and Treasury Functions in the Internalization Process
Introduction
MNEs 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 Process
Chief 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
© 2001 Prentice Hall

5. Location of Treasury Function in the Corporate Organizational Structure
© 2001 Prentice Hall

6. Global Debt Markets
Companies 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

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

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
© 2001 Prentice Hall

9. Equity Securities and the Euromarket
Equity 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
© 2001 Prentice Hall

10. 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
© 2001 Prentice Hall

11. Growth of Emerging Stock Markets
Emerging markets
Developed markets
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12. Offshore Financial Centers
Cities 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
© 2001 Prentice Hall

13. Characteristics of Offshore Financial Centers
Large foreign-
currency market
for loans/deposits
Favorable
regulatory
climate
Pass-through for
international
loan funds
Efficient and
experienced
financial
community
Offshore
Financial
Center
Economic and
political stability
Good
communications
Large net supplier
of funds to world
financial markets
Good supportive
services
© 2001 Prentice Hall

14. Internal Sources of Funds
Funds—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
© 2001 Prentice Hall

15. Internal Sources of Working Capital for MNEs
Parent
Company
Invests more
equity capital
Loans
Dividends,
royalties,
and fees
Guarantee
loans
French
Subsidiary
Loans
Extensions of
accounts payable
Brazilian
Subsidiary
© 2001 Prentice Hall

16. 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
© 2001 Prentice Hall

17. 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
© 2001 Prentice Hall

18. Multilateral Cash Flows
$150,000
French
Subsidiary
Italian
Subsidiary
$50,000
$200,000
$200,000
$200,000
German
Subsidiary
United Kingdom
Subsidiary
$100,000
© 2001 Prentice Hall

19. Multilateral Netting French Subsidiary Italian Subsidiary Clearing
$100,000
$150,000
Clearing
Account
$150,000
$100,000
German
Subsidiary
United Kingdom
Subsidiary
© 2001 Prentice Hall

20. Foreign-Exchange Risk Management
Translation 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
© 2001 Prentice Hall

21. Exposure-Management Strategy
Defining 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
© 2001 Prentice Hall

22. 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

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
© 2001 Prentice Hall

24. Capital Budgeting Decision in an International Context
Parent 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 Hall