International Financial Management

P G Apte

P.G.Apte International Financial Management 1

17.1 Introduction

• The essence of short term financial management

can be stated as
• Minimize the working capital needs consistent
with other policies
• Raise short term funds at the minimum possible
cost and deploy short term cash surpluses at the
maximum possible rate of return consistent with
the firm's risk preferences and liquidity needs

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17.1 Introduction (contd.)

• In a multinational context, the added dimensions

are the multiplicity of currencies and a much wider
array of markets and instruments for raising and
deploying funds
• Focus on cash management since it is complex
because of possibility of raising and deploying cash
in many currencies, many locations, and profit
opportunities presented by imperfections in
international money and foreign exchange markets

P.G.Apte International Financial Management 3

17.1 Introduction (contd.)

• Even a purely domestic firm or a firm with imports

and exports but no cross-border manufacturing
facilities can "internationalize" its cash
management if the government of the country
permits free capital inflows and outflows
• In India as of now, the capital account has not been
opened up

P.G.Apte International Financial Management 4

17.1 Introduction (contd.)

• Indian firms have been permitted access to foreign

money markets (through domestic banks) for pre-
shipment credits for exports and settlement of
import payments or through ECB, RDBs etc
• The Exchange Earners Foreign Currency (EEFC)
account facility

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17.1 Introduction (contd.)

• The passive approach confines itself to minimizing

cash needs and currency exposure as well as
optimal deployment of cash balances arising out of
the firm's operating requirements
• The active approach deliberately creates cash
positions to profit from perceived market
imperfections or the firm's supposedly superior
forecasting ability

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17.2 Short Term Borrowing and
Investment
• The principal dimensions of the borrowing-
investment decisions are the instrument, currency,
location of the financial center and any tax related
issues
• On a covered basis, the choice of currency of
borrowing does not matter.
• Only when the borrower firm holds views regarding
currency movements which are different from
market expectations as embodied in the forward
rate, does the currency of borrowing become an
important choice variable

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17.2 Short Term Borrowing and
Investment (contd.)
• On a covered basis the firm should be indifferent
between various currencies when it comes to
placing temporary excess funds since the covered
yields are identical
• Considerations such as availability of various
investment vehicles- deposits, CDs, CP, treasury bills
etc.- and their liquidity may lead to one currency
being favored over another

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17.3 Where should Surplus Cash be
Held?
• Apart from cost and return considerations, several
other factors influence the choice of currencies and
locations for holding cash balances
• The bid-ask spreads in exchange rate quotations
represent transaction costs of converting currencies
into one another

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17.3 Where should Surplus Cash be
Held? (contd.)
• Minimizing transaction costs
• Liquidity: Funds should be held in a currency in
which they are most likely to be needed
• Political risk
• Availability of investment vehicles and their liquidity
• Withholding taxes

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17.3 Where should Surplus Cash be
Held? (contd.)
• Investing surplus funds
• Choose appropriate investment vehicles so as to
maximize the interest income while at the same
time minimizing currency and credit risks and
ensuring sufficient liquidity to meet any
unforeseen cash requirements
• The major investment vehicles available for
short-term placement of funds are short term
bank deposits, fixed term money market
deposits such as CDs and financial and
commercial paper
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17.3 Where should Surplus Cash be
Held? (contd.)
• Main considerations in choosing an investment
vehicle
• Yield
• Marketability
• Exchange Rate Risk
• Price Risk
• Transactions Costs

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17.3 Where should Surplus Cash be
Held? (contd.)
• Financing Short-Term Deficits
• Careful handling of short-term deficits can lead to
significant savings
• Minimize the overall borrowing requirement
consistent with the firm's liquidity needs and to
fund these at the minimum possible all-in cost

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17.3 Where should Surplus Cash be
Held? (contd.)
• One of the cheapest ways of covering short-term
deficits is internal funds
• A centralized cash management system with cash
pooling described below can efficiently allocate
internal surpluses
• External sources of short-term funding consist of
overdraft facilities, fixed term bank loans and
advances and instruments like commercial paper,
trade and bankers' acceptances

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17.4 Centralized Management Versus
Decentralized Cash Management
• Centralized cash management has several
advantages
• Netting
• Exposure Management
• Cash Pooling
• Disadvantages of centralized management
• Some funds have to be held locally in each
subsidiary to meet unforeseen payments

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17.4 Centralized Management Versus
Decentralized Cash Management (contd.)

• Local problems in dealing with customers,

suppliers etc.
• Conflicts of interest can arise if a subsidiary is
not wholly owned but a joint venture with
minority local stake

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17.5 Cash Transmission

• Minimizing the unnecessary costs in the process of

collecting cash from debtors and making payments
to creditors; the costs arising from the so called
"float"
• The treasurer must try and minimize the float in the
cash collection cycle and take advantage of the float
in the cash payment cycle

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17.5 Cash Transmission (contd.)

• The banking systems in various countries have

evolved clearing mechanisms which aim at reducing
the delays between a payment instruction being
received and the payee actually being able to apply
the funds

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17.6 Summary

• Within the constraints imposed by the exchange

control and other regulations, a MNC has access to
a much wider menu of funding avenues and
investment vehicles for short-term funds
management
• Apart from funding and investment avenues, the
mechanics of efficient cash transmission and
configuration of bank accounts is an important
aspect of cash management in a MNC
• The decision to centralize cash management in a
separate cash management center needs to be
carefully evaluated

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