the multinational finance function

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© 2001 Prentice Hall 20-1

International Businessby

Daniels and Radebaugh

Chapter 20

The MultinationalFinance Function




ObjectivesTo 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 ofinflation and exchange-rate movement

To 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

MEANSOverlaying

Alternatives

Finance in International Business




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




VP, Sales/Marketing

Controller

Cash Manager Credit Manager

Exposure

Management

Budget

Planning

Bid Support Process Foreign

Currency

Global Finance Capital

Expenditure

Financial

Planning

Treasurer

VP, Finance VP, Operations VP, R&D

President and COO

Chairman and CEO

Board of Directors

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 thebusiness 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 factorsCompanies 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 branchin 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 isdenominated

– 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 homecountry 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




1986

3.60%

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 involvingshort-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 market

for loans/deposits

Offshore

Financial

Center

Good

communications

Pass-through forinternational

loan funds

Efficient andexperienced

financial

community

Favorable

regulatory

climate

Economic and

political stability

Large net supplier

of funds to world

financial markets

Good supportive

services

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

French

Subsidiary

Brazilian

Subsidiary

Parent

Company

Loans

Extensions of

accounts payable

Invests more

equity capitalLoans

Guarantee

loans

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 eachsubsidiary to settle intercompany obligations

– not as advantageous as netting




German

Subsidiary

$150,000

$200,000 $200,000

$100,000 United Kingdom

Subsidiary

French

Subsidiary$50,000

$50,000

$200,000

Italian

Subsidiary

Multilateral Cash Flows




French

Subsidiary

Italian

Subsidiary

German

Subsidiary

United Kingdom

Subsidiary

Clearing

Account

$100,000

$100,000$150,000

$150,000

Multilateral Netting




Foreign-Exchange Risk Management

Translation exposure—arises because, as the exchange rate

changes, the dollar value of the exposed asset or liabilitychanges

• 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 convertedinto 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 Strategy

Defining and measuring exposure

• MNE must forecast the degree of exposure in each majorcurrency 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 acost-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 thatof 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

the multinational finance function

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