■ THE GOAL IS TO MINIMIZE INTERNATIONAL CURRENCY RISKS.
QUESTIONS
10-1. HOW DOES MARKEL CORPORATION GAIN AND LOSE FROM FLUCTUATING
EXCHANGE RATES?
(LO 10.5; AACSB: Application of knowledge)
■ Markel quotes prices in its customers’ currencies. Foreign customers prefer this, and
this has earned Markel a strong market share in this industry.
■ When the U.S. dollar weakened significantly against the euro, Markel suffered
■ Explanation- Suppose Markel sells merchandise to its Spanish importer for €50,000,
10-2. WHAT IS HEDGING? WHY DO FIRMS THAT DO INTERNATIONAL BUSINESS
ENGAGE IN HEDGING?
(LO 10.5; AACSB: Application of knowledge)
■ Hedging enables a firm to manage its exposure to currency risk by using financial
■ Hedging- most common method for managing exposure.
■ If the hedge is perfect, the firm is protected against the risk of adverse changes in the
■ Banks offer forward contracts, options, and swap agreements to facilitate hedging.
■ Banks charge fees and interest payments on amounts borrowed to carry out these
■ Passive hedging– each exposure is hedged as it occurs and the hedge stays in place
■ Active hedging– the firm frequently reviews total exposure and hedges only a subset
10-3. WHAT IS A FORWARD CONTRACT? HOW DO SUCH CONTRACTS HELP
MARKEL?
(LO 10.5; AACSB: Application of knowledge)
■ A forward contract is an agreement to buy or sell currency at an agreed-upon
■ Markel buys forward contracts from banks to hedge exchange-rate exposure.
■ Example-
■ Markel enters a forward agreement to sell €50,000, at a date 90 days in the future and
■ This ensures that Markel receives a known dollar amount in the future for a sale made
■The goal of such hedging is to balance purchases and sales of foreign currencies to
■ When the dollar is expected to appreciate (go up in value) against the euro, Markel’s
● SUGGESTED SOLUTIONS TO CASE QUESTIONS
10-4. What are the implications for currency risk of TEK focusing its
manufacturing in the United States but generating most of its sales abroad?
Competitors like HP and Kodak are more geographically diversified in their
sourcing. What advantages does this create for them?
(LO 10.5; AACSB: Analytical Thinking)
■ Since TEK focuses its manufacturing in the U.S. and generates about half of its sales
abroad, the company faces foreign exchange exposure in three major areas:
transaction exposure, translation exposure, and operational exposure. TEK is subject to
■ Regarding operational exposure, TEK’s competitors have lower foreign exchange
exposure. Since Hewlett Packard manufactures in roughly 20 countries, it can use
operational tactics to reduce foreign exchange risk. For example, HP may create an
10-5. The case lists various approaches TEK follows to minimize its exposure to
currency risk. If hired by TEK, what other strategies and tactics would you
recommend to reduce the firm’s exposure even further? Justify your answer.
(LO 10.5; AACSB: Analytical Thinking)
■ TEK currently uses forward contracts and currency options. It might also consider
using a money market hedge technique to handle transaction exposure. This could be a
■ To protect against operational exposure, TEK might explore some creative financial
policies. While it may be hard to find another firm to participate, TEK might engage in
■ TEK might also engage in a currency swap if optimal conditions exist. Currency swaps
resembles back-to-back loans however they do not appear on a firm’s balance sheet. A
currency swap occurs when a firm and a swap dealer agree to exchange an equivalent
■ Regarding economic exposure, TEK might modify its product strategy to compete in
the most advantageous market segments and locate production operations in more
stable currency environments. TEK should develop tactics for pricing and promotion
under volatile currency environments.
10-6. TEK management attempts to maintain a reasonable ratio of debt to equity.
Most firms prefer relatively low levels of debt in their capital structures. Why?
What other approaches could TEK use to generate financing for its international
operations? What approaches can TEK use to transfer funds within its operations
worldwide?
(LO 10.1; LO 10.2; AACSB: Analytical Thinking)
■ Financial information for the precision instrument industry found on Value Line
suggests that the average debt-to-equity ratio for the industry is in the upper 30
percentile range, and TEK fell much lower than the industry average. Value Line
■ Using debt financing can add value to the firm because some governments allow
firms to deduct interest payments from their taxes. To minimize the possibility of
■ Since TEK gets much of its equity financing through the NYSE, it might try more debt
financing and intra-corporate financing. Debt financing could be beneficial as TEK would
not sacrifice ownership for capital. TEK might use international loans or issue bonds in
the global bond market. TEK could try intra-corporate financing where funds are
■ There are six typical methods for transferring funds within the MNE
◘ By using trade credits, subsidiaries can defer payment for goods received
◘ Dividend remittances may transfer funds from foreign subsidiaries to the
◘ Royalty payments are made to owners of intellectual property. If a subsidiary
◘ A Fronting loan between the parent and the subsidiary is channeled through a
large bank. Fronting loans may avoid restrictions that foreign governments may impose
◘ Transfer pricing (also known as intracorporate pricing) involves prices
◘ Multilateral netting is a strategic reduction of cash transfers within the MNE
10-7. The case describes approaches TEK follows to minimize its international tax
liability. Based on your reading of the chapter, how would you advise TEK
management to reduce its taxes around the world further?
(LO 10.6; AACSB: Analytical Thinking)
■ As part of TEK’s long-term tax strategy, it should enter into international tax planning.
This involves the lawful structuring the proper combination of transactions and the
ownership of entities to ensure tax effective routing of business activities and capital
■ A second strategy would be to establish a global manufacturing network to reduce
taxes. The strategic location of manufacturing facilities as part of TEK’s global strategy
total tax liability.
V. END OF CHAPTER QUESTIONS
● TEST YOUR COMPREHENSION
10-8. What are the components of the capital structure in the typical MNE? What
about MNEs in Japan and Germany? What about a typical firm in your country?
(LO 10.1; AACSB: Application of knowledge)
■ Although it depends on the firm and the industry, the typical mix of debt versus equity
10-9. From a managerial perspective, what are the advantages and disadvantages
of financing obtained from each of the following: equity, debt, and intra-corporate
sources?
(LO 10.1; LO 10.2; AACSB: Application of knowledge)
■ Equity financing, or selling shares of stock, allows new shareholders to obtain
■ Debt financing is borrowing money from a creditor in exchange for repayment of
■ Intra-corporate financing are funds provided by the firm’s headquarters in the form of
equity, loans, and trade credits. Advantages include increased flexibility on amounts
10-10. Suppose you had to raise capital to fund international value-adding
activities and investment projects. From what types of sources (e.g., stock
markets) would you most likely obtain each type of financing? What are financial
centers and where are they located?
(LO 10.2; AACSB: Application of knowledge)
■ First, compared to domestic firms, MNEs can access capital from a larger pool of
sources at competitive interest rates.
■ Exhibit 10.2 lists the share of major financial markets held by the [UK, France,
Germany], Japan, the U.S., and the rest of the world.
■ The United Kingdom, France, and Germany are home to the largest proportion of
foreign-exchange trading (45%).
■ Exhibit 10.3 lists the world’s largest stock exchanges.
■ Historically, exchanges in Europe, Japan, and the U.S. dominated the list.
■ More recently, exchanges in China have grown in size and influence.
■ NYSE Euronext (www.nyse.com) and NASDAQ OMX (www.nasdaq.com) are the
largest in terms of volume of shares traded.
■ Among the roughly 2,800 firms listed in NYSE Euronext, about 520 are foreign-owned
firms from 46 countries.
■ Besides the U.S. – countries with the most listed companies are Canada (146 firms),
China (73 firms), and the United Kingdom (34 firms).
10-11. What are the major tasks in managing working capital and cash flow for
international operations?
Visit MyManagementLab for suggested answers.
(LO 10.3; AACSB: Application of knowledge)
10-12. What are the major steps in capital budgeting? For what types of ventures
do international managers typically engage in capital budgeting?
(LO 10.4; AACSB: Application of knowledge)
■ Capital budgeting helps managers decide which international projects were
NPV in an international context can be complicated, so managers can use first the
project’s perspective then the parent’s perspective as tools to facilitate the decision.
10-13. What are the types of currency exposure? Why is currency exposure
potentially harmful to the firm’s international operations? How can managers
forecast currency exposure? What steps could you take to minimize currency
exposure?
Visit MyManagementLab for suggested answers.
(LO 10.5; AACSB: Application of knowledge)
10-14. Who are the major players in foreign-exchange trading?
(LO 10.5; AACSB: Application of knowledge)
■ There are three types of currency traders:
Hedgers seek to minimize the risk of exchange-rate fluctuations by buying for
words or similar financial instruments.
10-15. What are the major methods for translating foreign-currency denominated
financial statements into the financial statements of the parent firm?
(LO 10.6; AACSB: Application of knowledge)
■ Managers use one of two methods to do this:
The current rate method, which translates foreign currency balance sheet
■ Further, per U.S. accounting standards, if the functional currency of the subsidiary is
the local currency, the company must use the current rate method. If the functional
● APPLY YOUR UNDERSTANDING
10-16. Marite Perez is CEO of Havana, Inc., a large manufacturer of high-tech
medical equipment based in North Miami Beach, Florida. The firm makes vital
signs monitors, MRIs, X-ray machines, and other equipment for exploratory
medical diagnostics. Marite wants to rapidly expand the firm into foreign markets.
To accomplish this, she plans to invest much money in developing new products
and establishing production and marketing subsidiaries abroad. What can Marite
do to raise capital for these projects? What are the various methods that Marite
might employ to raise capital for her firm? What are the advantages and
disadvantages associated with each?
(LO 10.2; AACSB: Analytical Thinking)
● What can Marite do to raise capital for these projects?
■ Marite basically has two choices: to raise equity capital from investors or incurred
debt by borrowing money from banks. Assuming Havana, Inc. is publicly traded on one
of the major U.S. stock exchanges, she can increase the number of shares and sell
● What are the various methods that Marite might employ to raise capital for her
firm?
■ One thing she will want to consider is the nature of the high-tech medical equipment
● What are the advantages and disadvantages associated with each?
■ Equity financing would force Havana, Inc. to share ownership and lose some control,
10-17. Michael Norton is the president of Liberty Enterprises, a large MNE based
in Singapore that makes computers and related peripherals. The firm has many
subsidiaries around the world. Demand for Liberty’s products has been growing
in Asia and Europe, especially in Indonesia, Japan, France, and Spain. Michael
has always used external sources to finance the firm’s working capital needs.
Currently, with rapidly expanding business, he needs to access more working
capital. What is the feasibility of raising funds through intra-corporate sources?
What methods can Michael use to transfer funds within the firm? What should
Michael know about multilateral netting?
(LO 10.2; LO 10.3; AACSB: Analytical Thinking)
● What is the feasibility of raising funds through intra-corporate sources?
■ According to the short case, Liberty’s products have been successful in many affluent
and emerging countries. This suggests that the firm may have slack resources with
● What methods can Michael use to transfer funds within the firm?
■ There are six typical methods for transferring funds within the MNE
◘ By using trade credits, subsidiaries can defer payment for goods received
from the parent company. Credit terms are often longer than the typical 30 day credit.
◘ Dividend remittances may transfer funds from foreign subsidiaries to the
◘ Transfer pricing (also known as intra-corporate pricing) involves prices
◘ Multilateral netting is a strategic reduction of cash transfers within the MNE
● What should Michael know about the process of multilateral netting?
■ Multilateral netting involves reducing of cash transfers within the company by