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ch19 Multinational Financial Management
ch19 Multinational Financial Management
Multinational Financial
Management
19-4
Consider the following
exchange rates
US $ to buy 1 unit
Japanese yen 0.009
Australian dollar 0.650
19-5
What is an indirect quotation?
The number of units of a foreign
currency needed to purchase one U.S.
dollar, or the reciprocal of a direct
quotation.
Are you more likely to observe direct or
indirect quotations?
Most exchange rates are stated in terms of
an indirect quotation.
Except the British pound, which is usually in
terms of a direct quotation.
19-6
Calculate the indirect quotations
for yen and Australian dollar
# of units of foreign
currency per US $
Japanese yen 111.11
Australian dollar 1.5385
19-7
What is a cross rate?
The exchange rate between any two
currencies. Cross rates are actually calculated
on the basis of various currencies relative to the
U.S. dollar.
Cross rate between Australian dollar and the
Japanese yen.
Cross rate = (Yen / US Dollar) x (US Dollar / A. Dollar)
= 111.11 x 0.650
= 72.22 Yen / A. Dollar
The inverse of this cross rate yields:
0.0138 A. Dollars / Yen
19-8
Orange juice project:
Setting the appropriate price
A firm can produce a liter of orange
juice and ship it to Japan for $1.75 per
unit. If the firm wants a 50% markup
on the project, what should the juice
sell for in Japan?
Price = (1.75)(1.50)(111.11)
= 291.66 yen
19-9
Orange juice project:
Determining profitability
The product will cost 250 yen to produce and
ship to Australia, where it can be sold for 6
Australian dollars. What is the U.S. dollar
profit on the sale?
Cost in A. dollars = 250 yen (0.0138)
= 3.45 A. dollars
A. dollar profit = 6 – 3.45 = 2.55 A. dollars
U.S. dollar profit = 2.55 / 1.5385 = $1.66
19-10
What is exchange rate risk?
The risk that the value of a cash flow in
one currency translated to another
currency will decline due to a change in
exchange rates.
For example, in the last slide, a weakening
Australian dollar (strengthening dollar)
would lower the dollar profit.
The current international monetary system
is a floating rate system.
19-11
European Monetary Union
In 2002, the full implementation of
the “euro” was completed. The
national currencies of the 12
participating countries were phased
out in favor of the “euro.” The
newly formed European Central
Bank controls the monetary policy of
the EMU.
19-12
Member nations of the EMU
Austria Ireland
Belgium Italy
Finland Luxembourg
France Netherlands
Germany Portugal
Greece Spain
Notable European Union
countries not in the EMU:
Britain, Sweden, and
Denmark
19-13
What is a convertible currency?
A currency is convertible when the
issuing country promises to redeem
the currency at current market rates.
Convertible currencies are traded in
world currency markets.
19-14
What problems may arise when a
firm operates in a country whose
currency is not convertible?
It becomes very difficult for multi-
national companies to conduct
business because there is no easy way
to take profits out of the country.
Often, firms will barter for goods to
export to their home countries.
19-15
What is difference between
spot rates and forward rates?
Spot rates are the rates to buy
currency for immediate delivery.
Forward rates are the rates to buy
currency at some agreed-upon date
in the future.
19-16
When is the forward rate at a
premium to the spot rate?
If the U.S. dollar buys fewer units of a
foreign currency in the forward than in the
spot market, the foreign currency is selling
at a premium.
In the opposite situation, the foreign
currency is selling at a discount.
The primary determinant of the
spot/forward rate relationship is relative
interest rates.
19-17
What is interest rate parity?
Interest rate parity holds that investors
should expect to earn the same return in all
countries after adjusting for risk.
ft 1 k h
e0 1 k f
19-19
Does interest rate parity hold?
0.0095 1.0033
e0 1.0033
0.0095
1
e0
19-20
Which security offers the
highest return?
The Japanese security.
Convert $1,000 to yen in the spot market.
$1,000 x 111.111 = 111,111 yen.
Invest 111,111 yen in 30-day Japanese security. In
30 days receive 111,111 yen x 1.00333 = 111,481
yen.
Agree today to exchange 111,481 yen 30 days from
now at forward rate, 111,481/105.2632 = $1,059.07.
30-day return = $59.07/$1,000 = 5.907%, nominal
annual return = 12 x 5.907% = 70.88%.
19-21
What is purchasing power parity
(PPP)?
Purchasing power parity implies that the
level of exchange rates adjusts so that
identical goods cost the same amount
in different countries.
Ph = Pf(e0)
-OR-
e0 = Ph/Pf
19-22
If grapefruit juice costs $2.00 per liter
in the U.S. and PPP holds, what is the
price of grapefruit juice in Australia?
e0 = Ph/Pf
$0.6500 = $2.00/Pf
Pf = $2.00/$0.6500
= 3.0769 Australian dollars.
19-23
What impact does relative inflation have
on interest rates and exchange rates?
Lower inflation leads to lower interest
rates, so borrowing in low-interest
countries may appear attractive to
multinational firms.
However, currencies in low-inflation
countries tend to appreciate against those
in high-inflation rate countries, so the
effective interest cost increases over the
life of the loan.
19-24
International money and
capital markets
Eurodollar markets
a source of dollars outside the U.S.
International bonds
Foreign bonds – sold by foreign
19-26
Impact of multinational operations
Cash management
Distances are greater.
Access to more markets for loans and
for temporary investments.
Cash is often denominated in different
currencies.
19-27
Impact of multinational operations
Capital budgeting decisions
Foreign operations are taxed locally, and
then funds repatriated may be subject
to U.S. taxes.
Foreign projects are subject to political
risk.
Funds repatriated must be converted to
U.S. dollars, so exchange rate risk must
be taken into account.
19-28
Impact of multinational operations
Credit management
Credit is more important, because commerce to
lesser-developed countries often relies on credit.
Credit for future payment may be subject to
exchange rate risk.
Inventory management
Inventory decisions can be more complex, especially
when inventory can be stored in locations in different
countries.
Some factors to consider are shipping times, carrying
costs, taxes, import duties, and exchange rates.
19-29