CHAPTER 19

MULTINATIONAL FINANCIAL MANAGEMENT

19.1 MULTINATIONAL, OR GLOBAL, CORPORATIONS

• A corporation that operates in two or more countries.

• Decision making within the corporation may be centralized in the home
country, or may be decentralized across the countries in which the
corporation does business.
• Companies go “global” for seven primary reasons:
1. To seek production efficiency.
2. To avoid political and regulatory hurdles.
3. To seek new markets.
4. To seek raw materials and new technology.
5. To protect processes and products.
6. To diversify.
7. To retain customers.

19.2 MULTINATIONAL VERSUS DOMESTIC FINANCIAL MANAGEMENT

1. Different currency denominations.

2. Political risk
3. Economic and legal ramifications.
4. Role of governments
5. Language and cultural differences.

Exchange Rate
The number of units of a given currency that can be purchased for one unit of
another currency

19.3 THE INTERNATIONAL MONETARY SYSTEM

• The framework within which exchange rates are determined.

• The blueprint for international trade and capital flows.
• Exchange rate terminology
o Spot vs. forward exchange rate
▪ Spot exchange rate is the quoted price for a unit of foreign currency
to be delivered “on the spot” or within a very short period of time
▪ Forward exchange rate is the quoted price for a unit of foreign
currency to be delivered at a specified date in the future.
 o Fixed vs. floating exchange rate
▪ Fixed exchange rate is set by the government and is allowed to
fluctuate only slightly (if at all) around the desired rate, which is
called the par value.
▪ Floating or flexible exchange rate is not regulated by the
government, thus the demand and supply in the market determine
the currency’s value.
o Devaluation and revaluation
▪ Devaluation or revaluation is the technical term referring to the
decrease or increase in the stated par value of a currency whose
value is fixed.
o Depreciation and appreciation
▪ Depreciation or appreciation refers to a decrease or increase,
respectively, in the foreign exchange value of a floating currency.
These changes are caused by market forces rather than by
governments.

19.4 FOREIGN EXCHANGE RATE QUOTATIONS

• Floating rate
o Freely floating - Occurs when the exchange rate is determined by supply
and demand for the
o Managed floating - Occurs when there is significant government
intervention to control the exchange rate via manipulation of the currency’s
supply and
• Fixed rate
o No local currency - occurs when another country’s currency as its legal
tender due to lack of local currency
o Currency board arrangement - occurs when a country has its own
currency but commits to exchange it for a specified foreign money unit at a
fixed exchange rate and legislates domestic
o Fixed-peg arrangement - occurs when a country locks its currency to a
specific currency or basket of currencies

• Freely floating
o Exchange rate determined by the market’s supply and demand for the
currency. Governments may occasionally intervene and buy or sell their
currency to stabilize fluctuations.
• Managed floating
o Significant government intervention manages the exchange rate by
manipulating the currency’s supply and demand. The target exchange
rates are kept secret to prevent currency speculators from profiting from it.
• No local currency
 o The country uses either another country’s currency as its legal tender (like
the U.S. dollar in Ecuador) or else belongs to a group of countries that
share a currency (like the euro).
• Currency board arrangement
o The country technically has its own currency but commits to exchange it
for a specified foreign currency at a fixed exchange rate (like Argentina
before its January 2002 crisis).
• Fixed peg arrangement
o The country “pegs” its currency to another (or a basket of currencies) at a
fixed rate. Slight fluctuations are okay, but the rate must stay within a
desired range. For example, the Chinese yuan is pegged to a basket of
currencies.

19.5 TRADING FOREIGN EXCHANGE

US $ to Buy 1 Unit
Japanese Yen 0.009
Australian dollar 0.650

Are these currency prices direct or indirect quotations?

• Since they are prices of foreign currencies expressed in dollars, they are
direct quotations.

Japanese Yen: 1/.009 = 111.11

1/111.11 =.009 (indirect)
Interpretation: 1 Japanese yen is worth (or can be exchanged for) .009 US $

1. Assume that today 1 Japanese yen is worth .01095 US dollar. How many
Japanese yen would you receive for 1 US dollar?
Answer1 /.01095= 91.32
2. Assume that 1 US dollar can be exchanged for 105 Japanese yen or for
.80 euro. What is the euro/yen exchange rate?
Answer .007619/Japanese yen

• Indirect quotation
o The number of units of a foreign currency needed to purchase one
U.S. dollar, or the reciprocal of a direct quotation.

Number of units of Foreign Currency

per US $
Japanese Yen 111.11
Australian dollar 1.5385

Simply find the inverse of the direct quotations.

 1/111.11 =.009 (indirect)
Interpretation: 1 US $ is worth (or can be exchanged for) 111.11 of Japanese
yen
• Cross Rate
o The exchange rate between any two currencies. Cross rates are
actually calculated on the basis of various currencies relative to the
U.S. dollar.
o 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 no. of yen that one A. dollar could buy)
The inverse of this cross rate yields:
0.0138 A. Dollars/Yen (The no. of A. dollar that
one yen could buy)

• American Terms: The foreign exchange rate quotation that represents the
number of American dollars that can be bought with one unit of local
currency.
• European Terms: The foreign exchange rate quotation that represents the
units of local currency that can be bought with one US dollar
• Direct quotation: The home currency price of one unit of the foreign currency
• Indirect quotation: The foreign currency price of one unit of the home
currency.
• Spot Rate: The effective exchange rate of a foreign currency for delivery on
(approximately) the current day.
• Forward Exchange Rate: An agreed-upon price at which two currencies will
be exchanged at some future date.
• Discount on Forward Rate: The situation when the spot rate is less than the
forward rate
• Premium on Forward Rate: The situation when the spot rate is greater than
the forward
 When is the forward rate at a premium?
• 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.

19.6 INTEREST RATE PARITY

• A concept that specifies that investors should expect to earn the same return
in all countries after adjusting risk
• A principle that holds the relationship between spot and forward exchange
rates and interest rates
• Formula:
Forward exchange rate = (1 + rh)
Spot exchange rate = (1 + rf)

19.7 PURCHASING POWER PARITY

• Purchasing power parity implies that the level of exchange rates adjusts so
that identical goods cost the same amount in different countries.
• Formula
Ph = Pf (e0 ) or e0 = Ph / Pf

Spot rate = Ph / Pf
 Where:
Ph is the price of goods on the home country
Pf is the price of goods on the foreign country

Exchange Rate
• 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 application for determining profit, a
weakening/strengthening Australian dollar would impact the dollar profit.

19.8 INFLATION, 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.

19.9 INTERNATIONAL MONEY AND CAPITAL MARKETS

• Eurocredits
o Fixed term, floating-rate bank loans with no early repayment.
o An example is a eurodollar deposit, which is U.S. dollars deposited in a
bank outside the U.S.
• Eurodollar
o A US dollar deposited in a bank outside the United States.
• Eurobonds
o Medium-to long-term international market for fixed-and floating-rate debt.
o Underwritten by an international bank syndicate and sold to investors in
countries other than the one in whose currency the bond is denominated.
• Foreign bonds
o Issued in a capital market other than the issuer’s.
o The only thing foreign about it is the borrower’s nationality.