2001 Prentice Hall 20-1

International Business
by
Daniels and Radebaugh
Chapter 20
The Multinational
Finance Function
2001 Prentice Hall 20-2
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
OPERATIONS
OBJECTIVES
STRATEGY
EXTERNAL INFLUENCES
COMPETITIVE
ENVIRONMENT
PHYSICAL AND
SOCIETAL FACTORS


Functions
Marketing
Exporting and
importing
Global manufacturing
Supply chain
management
Accounting
FINANCE
Human resources
Modes
MEANS
Overlaying
Alternatives
Finance in International Business
2001 Prentice Hall 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

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VP, Sales/Marketing
Controller
Cash Manager Credit Manager
Exposure
Management
Budget
Planning
Bid Support Process Foreign
Currency
Global Finance Capital
Expenditure
Financial
Planning
Treasurer
VP, Finance VP, Operations VP, R&D
President and COO
Chairman and CEO
Board of Directors
Location of Treasury Function in the Corporate
Organizational Structure
2001 Prentice Hall 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 Receipts
other 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
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1986
3.60%
96.40%
1994
12.70%
87.30%
1998
93.10%
6.90%
Emerging markets
Developed markets
Growth of Emerging Stock Markets
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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
Large foreign-
currency market
for loans/deposits
Offshore
Financial
Center
Good
communications
Pass-through for
international
loan funds
Efficient and
experienced
financial
community
Favorable
regulatory
climate
Economic and
political stability
Large net supplier
of funds to world
financial markets
Good supportive
services
Characteristics of Offshore Financial Centers
2001 Prentice Hall 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
Dividends,
royalties,
and fees
French
Subsidiary
Brazilian
Subsidiary
Parent
Company
Loans
Extensions of
accounts payable
Invests more
equity capital
Loans
Guarantee
loans
Internal Sources of Working Capital for MNEs
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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
German
Subsidiary
$150,000
$200,000 $200,000
$100,000
United Kingdom
Subsidiary
French
Subsidiary
$50,000
$50,000
$200,000
Italian
Subsidiary
Multilateral Cash Flows
2001 Prentice Hall 20-19
French
Subsidiary
Italian
Subsidiary
German
Subsidiary
United Kingdom
Subsidiary
Clearing
Account
$100,000
$100,000 $150,000
$150,000
Multilateral Netting
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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
Competitive position of the company in markets
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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 should be at corporate level
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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
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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