International Cash Management

Centralized Cash Management

• While each subsidiary is managing its own working capital, a
centralized cash management group is needed to monitor, and
possibly manage, the parent-subsidiary and intersubsidiary cash
flows.
• International cash management can be segmented into two functions:
• optimizing cash flow movements, and
• investing excess cash.
Centralized Cash Management
• The centralized cash management division of an MNC cannot always
accurately forecast the events that may affect parent- subsidiary or
intersubsidiary cash flows.
• It should, however, be ready to react to any event by considering
• any potential adverse impact on cash flows, and
• how to avoid such adverse impacts.
Techniques to Optimize Cash Flows
Accelerating Cash Inflows
• The more quickly the cash inflows are received, the more quickly they
can be invested or used for other purposes.
• Common methods include the establishment of lockboxes around the
world (to reduce mail float) and preauthorized payments (direct
charging of a customer’s bank account).
Techniques to Optimize Cash Flows
Minimizing Currency Conversion Costs
• Netting reduces administrative and transaction costs through the
accounting of all transactions that occur over a period to determine
one net payment.
• A bilateral netting system involves transactions between two units,
while a multilateral netting system usually involves more complex
interchanges.
Techniques to Optimize Cash Flows
Managing Blocked Funds
• A government may require that funds remain within the country in
order to create jobs and reduce unemployment.
• The MNC should then reinvest the excess funds in the host country,
adjust the transfer pricing policy (such that higher fees have to be
paid to the parent), borrow locally rather than from the parent, etc.
Techniques to Optimize Cash Flows
Managing Intersubsidiary Cash Transfers
• A subsidiary with excess funds can provide financing by paying for its
supplies earlier than is necessary. This technique is called leading.
• Alternatively, a subsidiary in need of funds can be allowed to lag its
payments. This technique is called lagging.
Complications in Optimizing Cash Flows
Company-Related Characteristics
• When a subsidiary delays its payments to the other subsidiaries, the other
subsidiaries may be forced to borrow until the payments arrive.
Government Restrictions
• Some governments may prohibit the use of a netting system, or periodically
prevent cash from leaving the country.
Complications in Optimizing Cash Flows
Characteristics of Banking Systems
• The abilities of banks to facilitate cash transfers for MNCs may vary among
countries.
• The banking systems in different countries usually differ too.
 Investing Excess Cash
• Excess funds can be invested in domestic or foreign short-term
securities, such as Eurocurrency deposits, bills, and commercial
papers.
• Sometimes, foreign short-term securities have higher interest rates.
However, firms must also account for the possible exchange rate
movements.
 Investing Excess Cash
Centralized Cash Management
• Centralized cash management allows for more efficient usage of funds
and possibly higher returns.
• When multiple currencies are involved, a separate pool may be
formed for each currency. The investment securities may also be
denominated in the currencies that will be needed in the future.
 Investing Excess Cash
Determining the Effective Yield
• The effective rate for foreign investments
rf = ( 1 + if ) ( 1 + ef ) – 1
where if = the quoted interest rate on the investment
ef = the % D in the spot rate
• If the foreign currency depreciates over the investment period, the
effective yield will be less than the quoted rate.
 Investing Excess Cash
Implications of Interest Rate Parity (IRP)
• A foreign currency with a high interest rate will normally exhibit a
forward discount that reflects the differential between its interest rate
and the investor’s home interest rate.
• However, short-term foreign investing on an uncovered basis may still
result in a higher effective yield.
 Investing Excess Cash
Use of the Forward Rate as a Forecast
• If IRP exists, the forward rate can be used as a break-even point to
assess the short-term investment decision.
• The effective yield will be higher if the spot rate at maturity is more
than the forward rate at the time the investment is undertaken, and
vice versa.
 Investing Excess Cash
Use of Exchange Rate Forecasts
• Given an exchange rate forecast, the expected effective yield of a
foreign investment can be computed, and then compared with the
local investment yield.
• It may be useful to use probability distributions instead of point
estimates, or to compute the break-even exchange rate that will
equate foreign and local yields.
 Investing Excess Cash
Diversifying Cash Across Currencies
• If an MNC is not sure of how exchange rates will change over time, it
may prefer to diversify its cash among securities that are
denominated in different currencies.
• The degree to which such a portfolio will reduce risk depends on the
correlations among the currencies.
 Investing Excess Cash
Use of Dynamic Hedging to Manage Cash
• Dynamic hedging refers to the strategy of hedging when the
currencies held are expected to depreciate, and not hedging when
they are expected to appreciate.
• The overall performance is dependent on the firm’s ability to
accurately forecast the direction of exchange rate movements.
Topic Review
• Techniques to Optimize Cash Flows
• Accelerating Cash Inflows
• Minimizing Currency Conversion Costs
• Managing Blocked Funds
• Managing Intersubsidiary Cash Transfers
• Complications in Optimizing Cash Flows
• Company-Related Characteristics
• Government Restrictions
• Characteristics of Banking Systems
Topic Review
• Investing Excess Cash
• How to Invest Excess Cash
• Centralized Cash Management
• Determining the Effective Yield
• Implications of Interest Rate Parity
• Use of the Forward Rate as a Forecast
• Use of Exchange Rate Forecasts
• Diversifying Cash Across Currencies
• Use of Dynamic Hedging to Manage Cash
Topic Review
• Impact of International Cash Management on an MNC’s Value