Copyright © 2007 by The McGraw-Hill Companies, Inc. All rights reserved INTERNATIONAL FINANCIAL MANAGEMENT EUN / RESNICK Fourth Edition Chapter Objective: This chapter discusses various issues associated with multinational cash management. Multinational Cash Management

Copyright © 2007 by The McGraw-Hill Companies, Inc. All rights reserved Chapter Outline The Management of Multinational Cash Balances Cash Management Systems in Practice Transfer Pricing & Related Issues Blocked Funds

Copyright © 2007 by The McGraw-Hill Companies, Inc. All rights reserved The Management of International Cash Balances The size of cash balances The currency denomination Where these cash balances are located

Copyright © 2007 by The McGraw-Hill Companies, Inc. All rights reserved 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.

Copyright © 2007 by The McGraw-Hill Companies, Inc. All rights reserved The Size of Cash Balances Opportunity Costs Trading costs Total cost of holding cash C*C* Costs in dollars of holding cash Size of cash balance The investment income foregone when holding cash. Trading costs increase when the firm must sell securities to meet cash needs.

Copyright © 2007 by The McGraw-Hill Companies, Inc. All rights reserved Choice of Currency By maintaining cash balances in a particular currency, the MNC is essentially speculating (or hedging?) in that currency.

Copyright © 2007 by The McGraw-Hill Companies, Inc. All rights reserved 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?

Copyright © 2007 by The McGraw-Hill Companies, Inc. All rights reserved Cash Management Systems in Practice 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.

Copyright © 2007 by The McGraw-Hill Companies, Inc. All rights reserved Exposure Netting: an Example Consider a U.S. MNC with three subsidiaries and the following foreign exchange transactions ($000s): $10 $35 $40$30 $20 $25 $60 $40 $10 $30 $20 $30

Copyright © 2007 by The McGraw-Hill Companies, Inc. All rights reserved Exposure Netting: an Example Bilateral Netting would reduce the number of foreign exchange transactions by half: $10 $35 $40$30 $20 $40 $30 $20 $30 $20 $30 $10 $40$30$10 $30 $20 $60 $10 $35 $25 $60 $40 $20 $25 $10 $25 $10 $15 $10

Copyright © 2007 by The McGraw-Hill Companies, Inc. All rights reserved Multilateral Netting: an Example Consider simplifying the bilateral netting with multilateral netting: $25 $10 $20 $10 $15$10 $30 $15 $10 $40 $15 $40 $15

Copyright © 2003 by The McGraw-Hill Companies, Inc. All rights reserved 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 $40 Central depository $55

Copyright © 2007 by The McGraw-Hill Companies, Inc. All rights reserved Netting with Central Depository Consider the net cash flows of the affiliates with the rest of the world: AffiliateNet 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 Germany0$75,000($75,000) U.K.($40,000)($25,000)($15,000) Total($40,000)

Copyright © 2007 by The McGraw-Hill Companies, Inc. All rights reserved Netting with Central Depository Net cash flows after multilateral netting and net payments from external transactions Central depository $75 $15 $35