INTERNATIONAL FINANCIAL MANAGEMENT Fifth Edition EUN / RESNICK McGraw-Hill/Irwin Copyright © 2009 by The McGraw-Hill Companies, Inc. All rights reserved.

19 Multinational Cash Management Chapter Objective: This chapter discusses various issues associated with multinational cash management. 19 Chapter Nineteen Multinational Cash Management Fifth Edition 19-1

Chapter Outline The Management of Multinational Cash Balances Bilateral Netting of Internal and external Net Cash Flows Reduction in Precautionary Cash Flows Cash Management Systems in Practice 19-2

The Management of International Cash Balances The size of cash balances The currency denomination Where these cash balances are located 19-3

The Size of Cash Balances The optimal size of the firm’s cash balances depend upon: The cost of keeping “too much” cash on hand. i.e. the opportunity costs of holding cash The cost of not keeping enough cash on hand. i.e. the trading costs associated with having too little cash The variability of cash flows. 19-4

The Size of Cash Balances Trading costs increase when the firm must sell securities to meet cash needs. Trading costs Total cost of holding cash Costs in dollars of holding cash Opportunity Costs The investment income foregone when holding cash. C* Size of cash balance 19-5

Choice of Currency By maintaining cash balances in a particular currency, the MNC is essentially speculating (or hedging?) in that currency. 19-6

Where Cash Balances are Located. Should the firm have centralized cash management in the home country? Or should the firm let each affiliate handle it locally? Where are borrowing costs lowest and investment returns highest? 19-7

Netting: Bilateral and Multilateral Multilateral Netting Is an efficient and cost-effective mechanism for settling interaffiliate foreign exchange transactions. Not all countries allow MNCs to net payments By limiting netting, more unnecessary foreign exchange transactions flow through the local banking system. 19-8

Exposure Netting: an Example Consider a U.S. MNC with three subsidiaries and the following foreign exchange transactions ($000s): $20 $30 $40 $10 $10 $35 $30 $40 $25 $60 $20 $30 19-9

Exposure Netting: an Example Bilateral Netting would reduce the number of foreign exchange transactions by half: $20 $30 $10 $20 $30 $40 $40 $10 $35 $15 $40 $30 $25 $20 $10 $10 $10 $10 $35 $30 $40 $25 $25 $60 $60 $30 $20 $20 $10 $30 19-10

Multilateral Netting: an Example Consider simplifying the bilateral netting with multilateral netting: $40 $10 $10 $40 $15 $15 $15 $10 $10 $30 $40 $20 $15 $25 $10 $10 $10 19-11

Netting with Central Depository Some firms use a central depository as a cash pool to facilitate funds mobilization and reduce the chance of misallocated funds. $15 $55 Central depository $40 19-12

Netting with Central Depository Consider the net cash flows of the affiliates with the rest of the world: Affiliate Net Receipts from Multilateral Netting Net Excess Cash from Transactions with Third Parties Net Flow U.S. $55,000 $20,000 $35,000 Canada ($15,000) ($30,000) $15,000 Germany $75,000 ($75,000) U.K. ($40,000) ($25,000) Total 19-13

Netting with Central Depository Net cash flows after multilateral netting and net payments from external transactions $35 $15 Central depository $75 $15 19-14

Reduction in Precautionary Cash Balances An additional benefit of a centralized cash depository is that the MNC’s investment in precautionary cash balances can be substantially reduced without a reduction in its ability to cover unforeseen expenses. In the above examples, suppose that each affiliate had to have the cash on hand to make disbursements before it received what it was owed—that would result in a big cash drain on the firm. 19-15

Cash Management Systems in Practice The most frequently cited benefits of a multilateral netting system are: 1. The decrease in the expense associated with funds transfer, which in some cases can be over $1,000 for a large international transfer of foreign exchange. 2. The reduction in the number of foreign exchange transactions and the associated cost of making fewer but larger transactions. 3. The reduction in intracompany float, which is frequently as high as five days even for wire transfers. 4. The savings in administrative time. 5. The benefits that accrue from the establishment of a formal information system, which serves as the foundation for centrally managing transaction exposure and the investment of excess funds. 19-16

Exposure Netting Sample Problem In the following slides, a firm faces the following exchange rates: £1.00 = $2.00 €1.00 $1.50 SFr 1.00 $0.90 Beginning with the next slide, try to use multilateral netting to reduce the number of transactions as much as possible. 19-17

Exposure Netting SFr150 $150 €150 €150 £150 £150 $150 SFr150 $150 19-18

Exposure Netting £150× £1 $2.00 = $300 SFr150× SFr1 $0.90 = $135 €150× $1.50 = $225 Exposure Netting $225 $300 $150 $135 $135 SFr150 $150 $225 €150 $300 €150 £150 $225 $300 £150 $150 SFr150 $150 $135 SFr150 $135 $225 €150 £150 $300 19-19

Exposure Netting $75 $165 $90 $150 $15 $135 $15 $150 $225 $90 $225 $300 $75 $165 $300 $150 $135 $150 $135 $225 $75 $300 19-20

Exposure Netting $180 $90 $210 $15 $15 $180 $165 $150 $210 $90 $75 $150 + $75 = $225 $225 = $210 + $15 $180 = $165 + $15 $75 19-21

End Chapter Nineteen 19-22