You are on page 1of 25

The Multinational

Finance Function

2001 Prentice Hall

20-1

International
Business
Environments &
M. A. Bashar
Operations
Associate Professor
Department of Management
University of Chittagong

12-2

Objectives
To describe the multinational finance function and how it fits
in the MNEs 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 of inflation and exchange-rate movement
To highlight some of the financial aspects of the investment
decision

2001 Prentice Hall

20-3

Finance in International Business


OPERATIONS

EXTERNAL INFLUENCES

OBJECTIVES
PHYSICAL AND
SOCIETAL FACTORS
STRATEGY

MEANS
COMPETITIVE
ENVIRONMENT

Modes

2001 Prentice Hall

Overlaying
Alternatives

Functions
Marketing
Exporting and
importing
Global manufacturing
Supply chain
management
Accounting
FINANCE
Human resources

20-4

Introduction
MNEs need access to capital
Finance is integral to firms 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 resourcesgenerates funds from
internal and external sources
Allocates financial resourcesincreases
stockholders wealth by allocating funds to different
projects and investment opportunities
Manages cash flows
2001 Prentice Hall

20-5

Location of Treasury Function in the Corporate


Organizational Structure
B o a r d o f D ir e c t o r s
C h a ir m a n a n d C E O
P r e s id e n t a n d C O O
V P , S a le s / M a r k e t in g

C ash M anager

V P , F in a n c e

V P , O p e r a t io n s

C o n t r o lle r

T re a s u re r

C r e d it M a n a g e r

G lo b a l F in a n c e

E x p o s u re
M anagem ent

B udget
P la n n in g

C a p it a l
E x p e n d it u r e

B id S u p p o r t

2001 Prentice Hall

VP, R &D

F in a n c ia l
P la n n in g

P r o c e s s F o r e ig n
C u rre n c y

20-6

Global Debt Markets


Companies follow financing trends in their own country and
industry
Leveragedegree to which a firm funds the growth of the
business by debt
interest on debt is tax deductible
Equity capitalstocks or shares
dividends paid to investors are not deductible
Choice of debt versus equity affected by a variety of
factors
Companies 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 loanmade between a firm in country A
with a subsidiary in country B and a bank in country B
with a branch in country A
2001 Prentice Hall

20-7

Global Debt Markets (cont.)


Eurocurrenciesany 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
2001 Prentice Hall

20-8

Global Debt Markets (cont.)


International bond marketan attractive place to borrow
money that fills an important niche in financing
Tends to be less expensive than local markets
Foreign bondssold outside of the borrowers country but
in the currency of the country of issue
Eurobondsunderwritten by banking syndicate and sold
in countries other than the one in whose currency the
bond is denominated
sold in several financial centers
some have currency options allowing the creditor to
demand repayment in one of several currencies
Global bondcombination of domestic bond and
Eurobond
registered in each national market

2001 Prentice Hall

20-9

Equity Securities and the Euromarket


Equity securitiesinvestor 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 capitalistinvests money in a new venture in
exchange for stock
Equity-capital markets (stock markets)listing may be on
home country or foreign exchange
market capitalizationtotal 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

2001 Prentice Hall

20-10

Equity Securities and the Euromarket (cont.)


Euroequity marketmarket for shares sold outside the issuing
companys 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
Receiptsother markets for Euroequities
Global share offeringsimultaneous offering of actual
shares on different exchanges
Electronic trading of stocks is a major source of
competition for stock exchanges
2001 Prentice Hall

20-11

Growth of Emerging Stock Markets


1986
3.60%

Emerging markets
Developed markets

1994

96.40%

87.30%

12.70%

1998

6.90%

93.10%
2001 Prentice Hall

20-12

Offshore Financial Centers


Cities 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 centersextensive banking activities
involving short-term financial transactions
booking centerslittle banking activity
financial transactions recorded to take advantage
of secrecy and low tax rates
Good locations for establishing financial subsidiaries

2001 Prentice Hall

20-13

Characteristics of Offshore Financial Centers


Large foreigncurrency market
for loans/deposits
Pass-through for
international
loan funds

Favorable
regulatory
climate
Efficient and
experienced
financial
community

Offshore
Financial
Center

Economic and
political stability

Good
communications

Large net supplier


of funds to world
financial markets
2001 Prentice Hall

Good supportive
services

20-14

Internal Sources of Funds


Fundsworking capital, i.e., the difference between current
assets and current liabilities
Used to expand operations or satisfy demands for capital
Sources of fundsMNEs 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

2001 Prentice Hall

20-15

Internal Sources of Working Capital for MNEs

Parent
Company

Loans

Dividends,
royalties,
and fees

French
Subsidiary

Guarantee
loans

Loans
Extensions of
accounts payable
2001 Prentice Hall

Invests more
equity capital

Brazilian
Subsidiary

20-16

Internal Sources of Funds (cont.)


Global cash managementrequires the collection and payment
of cash resulting from the normal operational cycle
Generates and invests cash through dealings with
financial institutions
Assesses a companys 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

2001 Prentice Hall

20-17

Internal Sources of Funds (cont.)


Multilateral nettingcompany 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
each subsidiary to settle intercompany obligations
not as advantageous as netting

2001 Prentice Hall

20-18

Multilateral Cash Flows

French
Subsidiary

$150,000
$50,000

Italian
Subsidiary

$200,000
$200,000

$200,000
$50,000

German
Subsidiary

$100,000

2001 Prentice Hall

United Kingdom
Subsidiary

20-19

Multilateral Netting
French
Subsidiary

Italian
Subsidiary

$100,000

$150,000

Clearing
Account
$150,000

$100,000

German
Subsidiary

United Kingdom
Subsidiary

2001 Prentice Hall

20-20

Foreign-Exchange Risk Management


Translation exposurearises because, as the exchange
rate changes, the dollar value of the exposed asset or
liability changes
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 converted into dollars
Transaction exposurearises 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
2001 Prentice Hall
20-21
Competitive position of the company in markets

Exposure-Management Strategy
Defining and measuring exposure
MNE must forecast the degree of exposure in each
major currency in which it operates
exchange-rate movements are forecasted using
in-house or external experts
Reporting systemsubstantial 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
be at corporate level 20-22
2001should
Prentice Hall

Exposure-Management Strategy (cont.)


Centralized policytop management should determine hedging
policy
Corporate treasurer should be able to design and
implement a cost-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 strategiessafest position has exposed
assets equal to exposed liabilities
Operational strategiesinvolve 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
2001 Prentice Hall

20-23

Exposure-Management Strategy (cont.)


Formulating hedging strategies (cont.)
Contractual arrangements
forward contractestablishes a fixed exchange rate
for future transactions
foreign-currency optionpurchaser 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

2001 Prentice Hall

20-24

Capital Budgeting Decision in an International


Context
Parent 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 that of 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

2001 Prentice Hall

20-25

You might also like