0l1R0t PR0001t l0

kLLCMCk 3
AkICIL8kIAN1ISLVIAUDnI
CASL CvL8vlLW
ClLrus roducLs lnc ls a medlumslzed producer of clLrus
[ulce drlnks wlLh groves ln lndlan 8lver CounLy llorlda
unLll now Lhe company has conflned lLs operaLlons and
sales Lo Lhe unlLed SLaLes buL lLs CLC Ceorge Caynor
wanLs Lo expand lnLo Lurope 1he flrsL sLep would be Lo
seL up sales subsldlarles ln Spaln and Sweden Lhen Lo seL
up a producLlon planL ln Spaln and flnally Lo dlsLrlbuLe
Lhe producL LhroughouL Lhe Luropean common markeL
1he flrm's flnanclal manager 8uLh SchmldL ls enLhuslasLlc
abouL Lhe plan buL she ls worrled abouL Lhe lmpllcaLlons
of Lhe forelgn expanslon on Lhe flrm's flnanclal
managemenL process
W A mulLlnaLlonal corporaLlon ls one LhaL
operaLes ln Lwo or more counLrles
W llrms expand lnLo oLher counLrles
1o seek new markeLs
1o seek new supplles of raw maLerlals
1o galn new Lechnologles
1o galn producLlon efflclencles
1o avold pollLlcal and regulaLory obsLacles
1o reduce rlsk by dlverslflcaLlon
1he slx ma[or facLors whlch dlsLlngulsh
mulLlnaLlonal flnanclal managemenL from flnanclal
managemenL as pracLlced by a purely domesLlc
flrm are
W Currency dlfferences
W Lconomlc and legal dlfferences
W Language dlfferences
W CulLural dlfferences
W CovernmenL roles ollLlcal rlsk
US Do||ar kequ|red to 8uy Cne
Un|t of Iore|gn Currency
Luro 08
Swedlsh krona 01
W Are these currency pr|ces d|rect quotat|ons or
|nd|rect quotat|ons?
Slnce Lhey are prlces of forelgn currencles
expressed ln uS dollars Lhey are dlrecL
quoLaLlons
W Ca|cu|ate the |nd|rect quotat|ons for euros
and kronas
Currency per US 5
Luro 1/08 123
Swedlsh krona 1/01 10
Jhat |s a cross rate?
A cross rate is the exchange rate between any
two currencies not involving U.S. dollars. In
practice, cross rates are usually calculated Irom
direct or indirect rates. That is, on the basis oI
U.S. dollar exchange rates
ConL'd
W Cross 8aLe Luros/uollar x uollars/korona
Cross 8aLe 12300 x 01
Cross 8aLe 012300 Luros/krona
W Cross 8aLe kronas/uollar x uollars/Luro
Cross 8aLe 100000 x 08000
Cross 8aLe 8000 kronas/Luro
Assume C|trus roducts can produce a ||ter of orange
[u|ce and sh|p |t to Spa|n for 517S If the f|rm wants a
S0 percent markup on the product what shou|d the
orange [u|ce se|| for |n Spa|n?
W 1argeL rlce $ 173 x 13
1argeL rlce $ 263
W Spanlsh rlce $ 263 x 12300 euros/$
W Spanlsh rlce 328 euros
Now assume C|trus roducts beg|ns produc|ng the same ||ter of
orange [u|ce |n Spa|n 1he product costs 20 euros to produce
and sh|p to Sweden where |t can be so|d for 20 kronas Jhat
|s the do||ar prof|t on the sa|e?
20 euros 20 x 8000 kronas/euro
20 euros 1600 kronas
kronas proflL 20 1600
kronas proflL 400 kronas
uollar proflL 400 x 01 dollars/krona
uollar proflL $ 040
Lxchange rate r|sk
Lxchange rate r|sk |s the r|sk that the va|ue of a
cash f|ow |n one currency trans|ated from
another currency w||| dec||ne due to a change
|n exchange rates
8r|ef|y descr|be the current |nternat|ona| monetary
system now does the current system d|ffer from the
system that was |n p|ace pr|or to August 1971?
1he currenL sysLem ls a floaLlng raLe sysLem rlor
Lo 1971 a flxed exchange raLe sysLem was ln
effecL 1he uS dollar was Lled Lo gold CLher
currencles were Lled Lo Lhe dollar
Jhat |s a convert|b|e currency? Jhat prob|ems ar|se
when a mu|t|nat|ona| company operates |n a country
whose currency |s not convert|b|e?
A currency ls converLlble when Lhe lssulng
counLry promlses Lo redeem Lhe currency aL
currenL markeL raLes ConverLlble currencles are
Lraded ln world currency markeLs lL becomes
very dlfflculL for mulLlnaLlonal companles Lo
conducL buslness because Lhere ls no easy way
Lo Lake proflLs ouL of Lhe counLry
Jhat |s the d|fference between spot rates and
forward rates? Jhen |s the forward rate at a
prem|um to the spot rate? At a d|scount?
W A spoL raLe ls Lhe raLe applled Lo buy currency for
lmmedlaLe dellvery
W A forward raLe ls Lhe raLe applled Lo buy currency
aL some agreedupon fuLure daLe
W lf Lhe uS dollar buys fewer unlLs of a forelgn
currency ln Lhe forward Lhan ln Lhe spoL markeL
Lhe forelgn currency ls selllng aL a premlum
W ln Lhe opposlLe slLuaLlon Lhe forelgn currency ls
selllng aL a dlscounL
Jhat |s |nterest rate par|ty? Current|y you can exchange 1
euro for 08100 do||ar |n the 180day forward market and the
r|skfree rate on 180day secur|t|es |s 6 percent |n the Un|ted
States and 4 percent |n Spa|n Does |nterest rate par|ty ho|d? If
not wh|ch secur|t|es offer the h|ghest expected return?
W lnLeresL raLe parlLy lmplles LhaL lnvesLors
should expecL Lo earn Lhe same reLurn on
slmllarrlsk securlLles ln all counLrles
W AcLual lorward 8aLe 081
Annual home raLe 6
Annual forelgn raLe 4
W 1esL for arlLy uslng Lhe lnLeresL 8aLe arlLy
LquaLlon r
h
003000 r
f
002000
W lorward 8aLe/ SpoL 8aLe 1+r
h
/1+r
f
lorward 8aLe (103000 x 08000) / 102000
lorward 8aLe 0807843
W lf lnLeresL raLe parlLy holds Lhe compuLed
forward raLe would be Lhe same as Lhe observed
forward raLe so parlLy does noL hold
W A uS lnvesLor could dlrecLly lnvesL ln Lhe uS
securlLy and earn an annuallzed raLe of 6
AlLernaLlvely Lhe uS lnvesLor could converL
dollars Lo euros lnvesL ln Lhe Spanlsh securlLy and
Lhen converL proflL back lnLo dollars lf Lhe reLurn
on Lhls sLraLegy ls hlgher Lhan 6 Lhen Lhe
Spanlsh securlLy has Lhe hlgher raLe
Lxamp|e
8uy 51000 worth of euros |n the spot market
Do||ars x Spot Ind|rect uote (euros]do||ar)
1000 x 12S00 euro]do||ar
12S000 euros
Span|sh |nvestment return (|n euros)
12S000 x 102000
127S00 euros
8uy contract today to exchange euros |n 180 days at forward rate
At end of 180 days convert euro |nvestment to do||ars
127S00 x 081000 do||ars per euro
510327S
Ca|cu|ate the rate of return
5 327S ] 5 100000
327S per 180 days
Annua| return 6SS
1h|s |s h|gher than return on US secur|ty so Span|sh secur|t|es have h|gher
returns after ad[ust|ng for exchange rates
Jhat |s purchas|ng power par|ty? If grapefru|t [u|ce costs 5200
a ||ter |n the Un|ted States and purchas|ng power par|ty ho|ds
what shou|d be the pr|ce of grapefru|t [u|ce |n Spa|n?
W urchaslng power parlLy lmplles LhaL Lhe level
of exchange raLes ad[usLs so LhaL ldenLlcal
goods cosL Lhe same amounL ln dlfferenL
counLrles
W SpoL 8aLe
h
/
f
0800000 $ 200 /
f

f
2300 euros
1he |mpact of re|at|ve |nf|at|on on
|nterest rates and exchange rates
Lower lnflaLlon leads Lo lower lnLeresL raLes so
borrowlng ln lowlnLeresL counLrles may appear
aLLracLlve Lo mulLlnaLlonal flrms Powever
currencles ln lowlnflaLlon counLrles Lend Lo
appreclaLe agalnsL Lhose ln hlghlnflaLlon raLe
counLrles so Lhe Lrue lnLeresL cosL lncreases
over Lhe llfe of Lhe loan
1he |nternat|ona| cap|ta| markets
Lurodollar markeLs uollars held ouLslde Lhe uS
MosLly Lurope buL also elsewhere lnLernaLlonal
bonds lorelgn bonds Sold by forelgn borrower
buL denomlnaLed ln Lhe currency of Lhe counLry
of lssue Lurobonds Sold ln counLry oLher Lhan
Lhe one ln whose currency lL ls denomlnaLed
1o what extent do average cap|ta|
structures vary across d|fferent countr|es?
Larly sLudles suggesLed LhaL average caplLal
sLrucLures varled wldely among Lhe large
lndusLrlal counLrles Powever a recenL sLudy
whlch conLrolled for dlfferences ln accounLlng
pracLlces suggesLs LhaL caplLal sLrucLures are
more slmllar across dlfferenL counLrles Lhan
prevlously LhoughL
Iactors assoc|ated w|th the fo||ow|ng areas of
mu|t|nat|ona| work|ng cap|ta| management
(1) Cash managemenL ulsLances are greaLer Access Lo more
markeLs for loans and for Lemporary lnvesLmenLs Cash ls
ofLen denomlnaLed ln dlfferenL currencles
(2) CredlL managemenL CredlL ls more lmporLanL because
commerce Lo lesserdeveloped counLrles ofLen relles on
credlL CredlL for fuLure paymenL may be sub[ecL Lo
exchange raLe rlsk Many companles use exporL credlL rlsk
lnsurance when granLlng credlL Lo an lnLernaLlonal
cusLomer
(3) lnvenLory managemenL lnvenLory declslons can be more
complex especlally when lnvenLory can be sLored ln
locaLlons ln dlfferenL counLrles Some facLors Lo conslder
are shlpplng Llmes carrylng cosLs Laxes lmporL duLles
and exchange raLes
AHlO - FEHlYANTl - SYLVlA-YUDHl