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Multinationalvs.domesticfinancialmanagementExchangeratesandtradinginforeignexchangeInternationalmonetarysystemInternationalmoneyandcapitalmarketsCHAPTER19

MultinationalFinancialManagementMultinationalvs.domesticfinWhatisamultinationalcorporation?Acorporationthatoperatesintwoormorecountries.Whatisamultinationalcorpor1.Toseeknewmarkets.2.Toseekrawmaterials.3.Toseeknewtechnology.4.Toseekproductionefficiency.5.Toavoidpoliticalandregulatoryhurdles.6. Todiversify.Whydofirmsexpandintoothercountries?1.Toseeknewmarkets.Whydo1.Differentcurrencydenominations.2.Economicandlegalramifications.3.Languagedifferences.4.Culturaldifferences.5.Roleofgovernments.6.Politicalrisk.Whatarethesixmajorfactorsthatdistinguishmultinationalfromdomesticfinancialmanagement?1.Differentcurrencydenomina

U.S.$tobuy

1Unit

Japaneseyen0.009Australiandollar0.650

Arethesecurrencypricesdirectorindirectquotations?Sincetheyarepricesofforeigncurrenciesexpressedindollars,theyaredirectquotations.Considerthefollowingexchangerates: U.S.$tobuyArethesecuThenumberofunitsofforeigncurrencyneededtopurchaseoneU.S.dollar,orthereciprocalofadirectquotation.Whatisanindirectquotation?ThenumberofunitsofforeignCalculatetheindirectquotationsforyenandAustraliandollars.

#ofUnitsofForeign

CurrencyperU.S.$Japaneseyen 111.11Australiandollar 1.5385Yen: 1/0.009=111.11.A.Dollar: 1/0.650=1.5385.CalculatetheindirectquotatiTheexchangeratebetweenanytwocurrencies.CrossratesareactuallycalculatedonthebasisofvariouscurrenciesrelativetotheU.S.dollar.Whatisacrossrate?TheexchangeratebetweenanyCrossrate =x =111.11x0.650

=72.22yen/A.dollar.Crossrate =x =1.5385x0.009

=0.0138A.dollars/yen.CalculatethetwocrossratesbetweenyenandAustraliandollars.Yen

U.S.DollarsU.S.Dollar A.DollarA.Dollars

U.S.Dollars

U.S.Dollar YenCrossrate =Thetwocrossratesarereciprocalsofoneanother.Theycanbecalculatedbydividingeitherthedirectorindirectquotations.Note:ThetwocrossratesarereciprPrice=(1.75)(1.50)(111.11)

=291.66yen.ThefirmcanproducealiteroforangejuiceandshipittoJapanfor$1.75.Ifthefirmwantsa50%markupontheproduct,whatshouldthejuicesellforinJapan?Price=(1.75)(1.50)(111.11)T250yen =250(0.0138)=3.45A.dollars.6–3.45 =2.55Australiandollarprofit.1.5385A.dollars=1U.S.dollar.Dollarprofit=2.55/1.5385=$1.66.NowthefirmbeginsproducingtheorangejuiceinJapan.Theproductcosts250yentoproduceandshiptoAustralia,whereitcanbesoldfor6Australiandollars.Whatisthedollarprofitonthesale?250yen =250(0.0138)=3.45ATheriskthatthevalueofacashflowinonecurrencytranslatedtoanothercurrencywilldeclineduetoachangeinexchangerates.Forexample,inthelastslide,aweakeningAustraliandollar(strengtheningdollar)wouldlowerthedollarprofit.Whatisexchangeraterisk?TheriskthatthevalueofacThecurrentsystemisafloatingratesystem.Priorto1971,afixedexchangeratesystemwasineffect.TheU.S.dollarwastiedtogold.Othercurrenciesweretiedtothedollar.Describethecurrentandformerinternationalmonetarysystems.ThecurrentsystemisafloatiTheEuropeanMonetaryUnionIn2002,thefullimplementationofthe“euro”isexpectedtobecomplete.Thenationalcurrenciesofthe11participatingcountrieswillbephasedoutinfavorofthe“euro.”ThenewlyformedEuropeanCentralBankwillcontrolthemonetarypolicyoftheEMU.TheEuropeanMonetaryUnionInThe11MemberNationsoftheEuropeanMonetaryUnionAustriaBelgiumFinlandFranceGermanyIrelandItalyLuxembourgNetherlandsPortugalSpainEuropeanUnioncountriesnotintheEMU:BritainSwedenDenmarkGreeceThe11MemberNationsoftheAuAcurrencyisconvertiblewhentheissuingcountrypromisestoredeemthecurrencyatcurrentmarketrates.Convertiblecurrenciesaretradedinworldcurrencymarkets.Whatisaconvertiblecurrency?AcurrencyisconvertiblewhenItbecomesverydifficultformulti-nationalcompaniestoconductbusinessbecausethereisnoeasywaytotakeprofitsoutofthecountry.Often,firmswillbarterforgoodstoexporttotheirhomecountries.Whatproblemsarisewhenafirmoperatesinacountrywhosecurrencyisnotconvertible?ItbecomesverydifficultforSpotratesaretheratestobuycurrencyforimmediatedelivery.Forwardratesaretheratestobuycurrencyatsomeagreed-upondateinthefuture.Whatisthedifferencebetweenspotratesandforwardrates?SpotratesaretheratestobuWhenistheforwardrateatapremiumtothespotrate?IftheU.S.dollarbuysfewerunitsofaforeigncurrencyintheforwardthaninthespotmarket,theforeigncurrencyissellingatapremium.Intheoppositesituation,theforeigncurrencyissellingatadiscount.Theprimarydeterminantofthespot/forwardraterelationshipisrelativeinterestrates.WhenistheforwardrateataWhatisinterestrateparity?Interestrateparityholdsthatinvestorsshouldexpecttoearnthesamereturninallcountriesafteradjustingforrisk.ft=t-periodforwardexchangeratee0=today’sspotratekh=periodicinterestrateinthehomecountrykf=periodicinterestrateintheforeigncountryfte0=1+kh1+kf.Whatisinterestrateparity?IAssume1yen=$0.0095in30-dayforwardmarketandkNomfor30-dayrisk-freesecuritiesinJapanandU.S.=4%.Doesinterestrateparityhold?No.ft =$0.0095kh =4%/12=0.333%kf =4%/12=0.333%(More...)Assume1yen=$0.0095in30-dTherefore,ifinterestrateparityholdsthene0=$0.0095.However,weweregivenearlierthate0=$0.0090.fte0=1+kh1+kf=1.00331.0033$0.0095e0$0.0095e0=1.Therefore,ifinterestratepaWhatsecurityoffershighestreturn?Japanesesecurity.1. Convert$1,000toyeninspotmarket.$1,000x111.111=111,111yen.2. Invest111,111yenin30-dayJapanesesecurity.In30daysreceive111,111yenx1.00333=111,481yen.3. Agreetodaytoexchange111,481yen30daysfromnowatforwardrate.

111,481/105.2632=$1,059.07.4. 30-dayreturn=$59.07/$1,000=5.907%,nominalannualreturn=12x5.907%=70.88%.WhatsecurityoffershighestrWhatispurchasingpowerparity(PPP)?Purchasingpowerparityimpliesthatthelevelofexchangeratesadjustssothatidenticalgoodscostthesameamountindifferentcountries.Ph=Pf(e0)ore0=Ph/Pf.WhatispurchasingpowerparitIfgrapefruitjuicecosts$2.00/literin

U.S.andPPPholds,whatisthepriceofgrapefruitjuiceinAustralia?PPP =e0=Ph/Pf$0.6500 =$2.00/PfPf =$2.00/$0.6500 =3.0769Australiandollars.Ifgrapefruitjuicecosts$2.0Lowerinflationleadstolowerinterestrates,soborrowinginlow-interestcountriesmayappearattractivetomultinationalfirms.However,currenciesinlow-inflationcountriestendtoappreciateagainstthoseinhigh-inflationratecountries,sotheeffectiveinterestcostincreasesoverthelifeoftheloan.Whatimpactdoesrelativeinflationhaveoninterestratesand

exchangerates?LowerinflationleadstolowerEurodollarmarketsasourceofdollarsoutsidetheU.S.InternationalbondsForeignbonds:Soldbyforeignborrower,butdenominatedinthecurrencyofthecountryofissue.Eurobonds:Soldincountryotherthantheoneinwhosecurrencythebondsaredenominated.Describetheinternationalmoneyandcapitalmarkets.EurodollarmarketsDescribetheTowhatextentdoaveragecapitalstructuresvaryacrossdifferentcountries?Previousstudiessuggestedthataveragecapitalstructuresvaryamongthelargeindustrialcountries.However,arecentstudy,whichcontrolledfordifferencesinaccountingpractices,suggeststhatcapitalstructuresaremoresimilaracrossdifferentcountriesthanpreviouslythought.TowhatextentdoaveragecapiDistancesaregreater.Accesstomoremarketsforloansandfortemporaryinvestments.Cashisoftendenominatedindifferentcurrencies.Whatistheimpactofmultinationaloperationsoneachofthefollowingtopics?CashManagementDistancesaregreater.WhatisForeignoperationsaretaxedlocally,andthenfundsrepatriatedmaybesubjecttoU.S.taxes.Foreignprojectsaresubjecttopoliticalrisk.FundsrepatriatedmustbeconvertedtoU.S.dollars,soexchangerateriskmustbetakenintoaccount.CapitalBudgetingDecisionsForeignoperationsaretaxedlCreditismoreimportant,becausecommercetolesser-developedcountriesoftenreliesoncredit.Creditforfuturepaymentmaybesubjecttoexchangeraterisk.CreditManagementCreditismoreimportant,becaInventorydecisionscanbemorecomplex,especiallywheninventorycanbestoredinlocationsindifferentcountries.Somefactorstoconsiderareshippingtimes,carryingcosts,taxes,importduties,andexchangerates.InventoryManagementInventorydecisionscanbemorCapitalBudgetinginForeignCountriesCountrySingaporeIndia&ThailandMethodAverageAccountingReturn

(AAR)PaybackPeriodCommentDividestheaverageNetIncomeofaprojectbythatproject’saveragebookvalueofequity.PreferredbyIndianandThaifinancialmanagersbecauseofrelativesimplicity.CapitalBudgetinginForeignCMultinationalvs.domesticfinancialmanagementExchangeratesandtradinginforeignexchangeInternationalmonetarysystemInternationalmoneyandcapitalmarketsCHAPTER19

MultinationalFinancialManagementMultinationalvs.domesticfinWhatisamultinationalcorporation?Acorporationthatoperatesintwoormorecountries.Whatisamultinationalcorpor1.Toseeknewmarkets.2.Toseekrawmaterials.3.Toseeknewtechnology.4.Toseekproductionefficiency.5.Toavoidpoliticalandregulatoryhurdles.6. Todiversify.Whydofirmsexpandintoothercountries?1.Toseeknewmarkets.Whydo1.Differentcurrencydenominations.2.Economicandlegalramifications.3.Languagedifferences.4.Culturaldifferences.5.Roleofgovernments.6.Politicalrisk.Whatarethesixmajorfactorsthatdistinguishmultinationalfromdomesticfinancialmanagement?1.Differentcurrencydenomina

U.S.$tobuy

1Unit

Japaneseyen0.009Australiandollar0.650

Arethesecurrencypricesdirectorindirectquotations?Sincetheyarepricesofforeigncurrenciesexpressedindollars,theyaredirectquotations.Considerthefollowingexchangerates: U.S.$tobuyArethesecuThenumberofunitsofforeigncurrencyneededtopurchaseoneU.S.dollar,orthereciprocalofadirectquotation.Whatisanindirectquotation?ThenumberofunitsofforeignCalculatetheindirectquotationsforyenandAustraliandollars.

#ofUnitsofForeign

CurrencyperU.S.$Japaneseyen 111.11Australiandollar 1.5385Yen: 1/0.009=111.11.A.Dollar: 1/0.650=1.5385.CalculatetheindirectquotatiTheexchangeratebetweenanytwocurrencies.CrossratesareactuallycalculatedonthebasisofvariouscurrenciesrelativetotheU.S.dollar.Whatisacrossrate?TheexchangeratebetweenanyCrossrate =x =111.11x0.650

=72.22yen/A.dollar.Crossrate =x =1.5385x0.009

=0.0138A.dollars/yen.CalculatethetwocrossratesbetweenyenandAustraliandollars.Yen

U.S.DollarsU.S.Dollar A.DollarA.Dollars

U.S.Dollars

U.S.Dollar YenCrossrate =Thetwocrossratesarereciprocalsofoneanother.Theycanbecalculatedbydividingeitherthedirectorindirectquotations.Note:ThetwocrossratesarereciprPrice=(1.75)(1.50)(111.11)

=291.66yen.ThefirmcanproducealiteroforangejuiceandshipittoJapanfor$1.75.Ifthefirmwantsa50%markupontheproduct,whatshouldthejuicesellforinJapan?Price=(1.75)(1.50)(111.11)T250yen =250(0.0138)=3.45A.dollars.6–3.45 =2.55Australiandollarprofit.1.5385A.dollars=1U.S.dollar.Dollarprofit=2.55/1.5385=$1.66.NowthefirmbeginsproducingtheorangejuiceinJapan.Theproductcosts250yentoproduceandshiptoAustralia,whereitcanbesoldfor6Australiandollars.Whatisthedollarprofitonthesale?250yen =250(0.0138)=3.45ATheriskthatthevalueofacashflowinonecurrencytranslatedtoanothercurrencywilldeclineduetoachangeinexchangerates.Forexample,inthelastslide,aweakeningAustraliandollar(strengtheningdollar)wouldlowerthedollarprofit.Whatisexchangeraterisk?TheriskthatthevalueofacThecurrentsystemisafloatingratesystem.Priorto1971,afixedexchangeratesystemwasineffect.TheU.S.dollarwastiedtogold.Othercurrenciesweretiedtothedollar.Describethecurrentandformerinternationalmonetarysystems.ThecurrentsystemisafloatiTheEuropeanMonetaryUnionIn2002,thefullimplementationofthe“euro”isexpectedtobecomplete.Thenationalcurrenciesofthe11participatingcountrieswillbephasedoutinfavorofthe“euro.”ThenewlyformedEuropeanCentralBankwillcontrolthemonetarypolicyoftheEMU.TheEuropeanMonetaryUnionInThe11MemberNationsoftheEuropeanMonetaryUnionAustriaBelgiumFinlandFranceGermanyIrelandItalyLuxembourgNetherlandsPortugalSpainEuropeanUnioncountriesnotintheEMU:BritainSwedenDenmarkGreeceThe11MemberNationsoftheAuAcurrencyisconvertiblewhentheissuingcountrypromisestoredeemthecurrencyatcurrentmarketrates.Convertiblecurrenciesaretradedinworldcurrencymarkets.Whatisaconvertiblecurrency?AcurrencyisconvertiblewhenItbecomesverydifficultformulti-nationalcompaniestoconductbusinessbecausethereisnoeasywaytotakeprofitsoutofthecountry.Often,firmswillbarterforgoodstoexporttotheirhomecountries.Whatproblemsarisewhenafirmoperatesinacountrywhosecurrencyisnotconvertible?ItbecomesverydifficultforSpotratesaretheratestobuycurrencyforimmediatedelivery.Forwardratesaretheratestobuycurrencyatsomeagreed-upondateinthefuture.Whatisthedifferencebetweenspotratesandforwardrates?SpotratesaretheratestobuWhenistheforwardrateatapremiumtothespotrate?IftheU.S.dollarbuysfewerunitsofaforeigncurrencyintheforwardthaninthespotmarket,theforeigncurrencyissellingatapremium.Intheoppositesituation,theforeigncurrencyissellingatadiscount.Theprimarydeterminantofthespot/forwardraterelationshipisrelativeinterestrates.WhenistheforwardrateataWhatisinterestrateparity?Interestrateparityholdsthatinvestorsshouldexpecttoearnthesamereturninallcountriesafteradjustingforrisk.ft=t-periodforwardexchangeratee0=today’sspotratekh=periodicinterestrateinthehomecountrykf=periodicinterestrateintheforeigncountryfte0=1+kh1+kf.Whatisinterestrateparity?IAssume1yen=$0.0095in30-dayforwardmarketandkNomfor30-dayrisk-freesecuritiesinJapanandU.S.=4%.Doesinterestrateparityhold?No.ft =$0.0095kh =4%/12=0.333%kf =4%/12=0.333%(More...)Assume1yen=$0.0095in30-dTherefore,ifinterestrateparityholdsthene0=$0.0095.However,weweregivenearlierthate0=$0.0090.fte0=1+kh1+kf=1.00331.0033$0.0095e0$0.0095e0=1.Therefore,ifinterestratepaWhatsecurityoffershighestreturn?Japanesesecurity.1. Convert$1,000toyeninspotmarket.$1,000x111.111=111,111yen.2. Invest111,111yenin30-dayJapanesesecurity.In30daysreceive111,111yenx1.00333=111,481yen.3. Agreetodaytoexchange111,481yen30daysfromnowatforwardrate.

111,481/105.2632=$1,059.07.4. 30-dayreturn=$59.07/$1,000=5.907%,nominalannualreturn=12x5.907%=70.88%.WhatsecurityoffershighestrWhatispurchasingpowerparity(PPP)?Purchasingpowerparityimpliesthatthelevelofexchangeratesadjustssothatidenticalgoodscostthesameamountindifferentcountries.Ph=Pf(e0)ore0=Ph/Pf.WhatispurchasingpowerparitIfgrapefruitjuicecosts$2.00/literin

U.S.andPPPholds,whatisthepriceofgrapefruitjuiceinAustralia?PPP =e0=Ph/Pf$0.6500 =$2.00/PfPf =$2.00/$0.6500 =3.0769Australiandollars.Ifgrapefruitjuicecosts$2.0Lowerinflationleadstolowerinterestrates,soborrowinginlow-interestcountriesmayappearattractivetomultinationalfirms.However,currenciesinlow-inflationcountriestendtoappreciateagainstthoseinhigh-inflationratecountries,sotheeffectiveinterestcostincreasesoverthelifeoftheloan.Whatimpactdoesrelativeinflationhaveoninterestratesand

exchangerates?LowerinflationleadstolowerEurodollarmarketsasourceofdollarsoutsidetheU.S.InternationalbondsForeignbonds:Soldbyforeignborrower,butdenominatedinthecurrencyofthecountryofissu

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