Copyright © 2007 by The McGraw-Hill Companies, Inc. All rights reserved. 19-0 INTERNATIONAL FINANCIAL MANAGEMENT EUN / RESNICK Fourth Edition.

Copyright © 2007 by The McGraw-Hill Companies, Inc. All rights reserved. 19-1

INTERNATIONALFINANCIAL

MANAGEMENT

EUN / RESNICK

Fourth Edition


INTERNATIONALFINANCIAL

MANAGEMENT

EUN / RESNICK

Fourth Edition

Chapter Objective:

This chapter discusses various issues associated with multinational cash management.

19Chapter

Nineteen

Multinational Cash Management


Chapter Outline

The Management of Multinational Cash Balances Cash Management Systems in Practice Transfer Pricing & Related Issues Blocked Funds


The Management of International Cash Balances

The size of cash balances The currency denominationWhere these cash balances are located


The Size of Cash Balances

The optimal size of the firm’s cash balances depend upon:

The cost of keeping “too much” cash on hand. i.e. the opportunity costs of holding cash

The cost of not keeping enough cash on hand.i.e. the trading costs associated with having too little cash

The variability of cash flows.


The Size of Cash Balances

Opportunity Costs

Trading costs

Total cost of holding cash

C*

Cos

ts in

dol

lars

of

hold

ing

cash

Size of cash balance

The investment income foregone when holding cash.

Trading costs increase when the firm must sell securities to meet cash needs.


Choice of Currency

By maintaining cash balances in a particular currency, the MNC is essentially speculating (or hedging?) in that currency.


Where Cash Balances are Located.

Should the firm have centralized cash management in the home country?

Or should the firm let each affiliate handle it locally?

Where are borrowing costs lowest and investment returns highest?


Cash Management Systems in Practice

Multilateral Netting Is an efficient and cost-effective mechanism for settling

interaffiliate foreign exchange transactions. Not all countries allow MNCs to net payments

By limiting netting, more unnecessary foreign exchange transactions flow through the local banking system.


Exposure Netting: an Example

Consider a U.S. MNC with three subsidiaries and the following foreign exchange transactions ($000s):

$10 $35 $40$30

$20

$25 $60

$40$10

$30

$20$30


Exposure Netting: an Example

Bilateral Netting would reduce the number of foreign exchange transactions by half:

$10 $35 $40$30

$20

$40

$30

$20$30

$20$30$10

$40$30$10

$30$20

$60

$10 $35$25

$60

$40$20

$25

$10

$25

$10$15

$10


Multilateral Netting: an Example

Consider simplifying the bilateral netting with multilateral netting:

$25 $10$20

$10

$10$10

$15 $10

$10

$30 $15 $10

$10

$40$15

$15 $40$40

$15


Netting with Central Depository

Some firms use a central depository as a cash pool to facilitate funds mobilization and reduce the chance of misallocated funds.

$15

$40

Central depository

$55



Consider the net cash flows of the affiliates with the rest of the world:

Affiliate Net Receipts from Multilateral Netting

Net Excess Cash from Transactions with Third Parties

Net Flow

U.S. $55,000 $20,000 $35,000

Canada ($15,000) ($30,000) $15,000

Germany 0 $75,000 ($75,000)

U.K. ($40,000) ($25,000) ($15,000)

Total ($40,000)



Net cash flows after multilateral netting and net payments from external transactions

Central depository

$75 $15

$15$35


Transfer Pricing & Related Issues

The Transfer Price is the price that for accounting purposes, is assigned to goods and services flowing from one division of a firm to another division.

Controversial even for a domestic firm. Consider the example of a firm that has one division

that mills lumber and another that makes furniture. The transfer price of the lumber is a political as well as economic and accounting issue.


Transfer Pricing & Related Issues

For MNC, there exists the added complications of: Differences in tax rates.

Import duties and quotas.

Exchange rate restrictions on the part of the host country.

Most countries have regulations controlling transfer pricing. In the U.S., the tax code requires transfer prices to be

arms length prices.


Arms Length Price

A price that a willing seller would charge a willing unrelated buyer.

The IRS prescribes three methods for estimating an arms length price Comparable uncontrolled price. Resale price: the price at which the good is resold by

the affiliate is reduced by overhead and profit. Cost-plus approach: an appropriate profit is added to

the cost of the manufacturing affiliate.


Blocked Funds

A form of political risk is the risk that the foreign government may impose exchange restrictions on its own currency.

Several methods exist for moving blocked funds:Transfer pricingUnbundling servicesParallel and back-to-back loansSwaps


Blocked Funds

Additional strategies for unblocking funds:

Export creation

Direct negotiation

Using the blocked funds to buy goods and services for the MNC.For example, use the National Airlines of the host country for travel of executives of the MNC, and pay for the tickets with the blocked funds.

Transfer local expatriates from home payroll to the local subsidiaries payroll.


End Chapter Nineteen

Copyright © 2007 by The McGraw-Hill Companies, Inc. All rights reserved. 19-0 INTERNATIONAL FINANCIAL MANAGEMENT EUN / RESNICK Fourth Edition.

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