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Topics to Stimulate Class Discussion
1. Should international cash management be conducted at the subsidiary level or at the centralized level?
Elaborate.
2. What is the use of netting to an MNC?
3. How can a firm deal with blocked funds?
4. Assume that as a treasurer of a U.S. corporation, you believe that the British pound’s forward rate is
an accurate forecast of the pound’s future spot rate. What does this imply about your decision of
whether to invest cash in the U.S. or in the U.K.?
POINT/COUNTER-POINT:
Should Interest Rate Parity Prevent MNCs From Investing in Foreign
Currencies?
POINT: Yes. Currencies with high interest rates have large forward discounts according to interest rate
parity. To the extent that the forward rate is a reasonable forecast of the future spot rate, investing in a
foreign country is not feasible.
COUNTER-POINT: No. Even if interest rate parity holds, MNCs should still consider investing in a
foreign currency. The key is their expectations of the future spot rate. If their expectations of the future spot
rate are higher than the forward rate, the MNC would benefit from investing in a foreign currency.
WHO IS CORRECT? Use the Internet to learn more about this issue. Which argument do you support?
Offer your own opinion on this issue.
ANSWER: The key is whether the MNC can more accurately predict the future spot rate better than what
is implied by the forward rate. If it has confidence that the future spot rate will be higher than today’s
forward rate, it may be willing to invest in a foreign currency.
Answers to End of Chapter Questions
1. International Cash Management. Discuss the general functions involved in international cash
management. Explain how the MNC’s optimization of cash flow can distort the profits of each
subsidiary.
ANSWER: The general functions of international cash management are optimizing cash flows and
investing excess cash. These functions combined will lead to efficient usage of funds.
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International Cash Management 2
2. Netting. Explain the benefits of netting. How can a centralized cash management system be beneficial
to the MNC?
A centralized cash management system is beneficial in that it allows for netting, which can reduce
transactions costs and improve cash budgeting. In addition, it can increase yields on short-term
investments by pooling excess cash of various subsidiaries.
3. Leading and Lagging. How can an MNC implement leading and lagging techniques to help
subsidiaries in need of funds?
4. International Fisher Effect. If a U.S. firm believes that the international Fisher effect holds, what are
the implications regarding a strategy of continually attempting to generate high returns from investing
in currencies with high interest rates?
5. Investing Strategy. Tallahassee Co. has $2 million in excess cash that it has invested in Mexico at an
annual interest rate of 60 percent. The U.S. interest rate is 9 percent. By how much would the
Mexican peso have to depreciate to cause such a strategy to backfire?
1 + 9%
1 + 60% -1 = - 31.875%
6. Investing Strategy. Why would a U.S. firm consider investing short-term funds in euros even when it
does not have any future cash outflows in euros?
7. Covered Interest Arbitrage. Evansville, Inc. has $2 million in cash available for 90 days. It is
considering the use of covered interest arbitrage, since the euro’s 90-day interest rate is higher than the
U.S. interest rate. What will determine whether this strategy is feasible?
would not be feasible.
8. Effective Yield. Fort Collins, Inc. has $1 million in cash available for 30 days. It can earn 1% on a
30-day investment in the U.S. Alternatively, if it converts the dollars to Mexican pesos, it can earn 1
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International Cash Management 3
1/2% on a Mexican deposit. The spot rate of the Mexican peso is $.12. The spot rate 30 days from
now is expected to be $.10. Should Ft. Collins invest its cash in the U.S. or in Mexico? Substantiate
your answer.
9. Effective Yield. Rollins, Inc., has $3 million in cash available for 180 days. It can earn 7% on a U.S.
Treasury bill or 9% on a British Treasury bill. The British investment does require conversion of
dollars to British pounds. Assume that interest rate parity holds and that Rollins believes the 180-day
forward rate is a reliable predictor of the spot rate to be realized 180 days from now. Would the British
investment provide an effective yield that is below, above, or equal to the yield on the U.S. investment?
Explain your answer.
10. Effective Yield. Repeat question 9, but this time assume that Rollins, Inc., expects the 180-day
forward rate of the pound to substantially overestimate the spot rate to be realized in 180 days.
11. Effective Yield. Repeat question 9, but this time assume that Rollins, Inc., expects the 180-day
forward rate of the pound to substantially underestimate the spot rate to be realized in 180 days.
12. Effective Yield. Assume that the one-year U.S. interest rate is 10% and the one-year Canadian interest
rate is 13%. If a U.S. firm invests its funds in Canada, by what percentage will the Canadian dollar
have to depreciate to make its effective yield the same as the U.S. interest rate from the U.S. firm’s
perspective?
13. Investing in a Currency Portfolio. Why would a firm consider investing in a portfolio of foreign
currencies instead of just a single foreign currency?
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International Cash Management 4
14. Interest Rate Parity. Dallas Co. has determined that the interest rate on euros is 16 percent while the
U.S. interest rate is 11 percent for one-year Treasury bills. The one-year forward rate of the euro has a
discount of 7 percent. Does interest rate parity exist? Can Dallas achieve a higher effective yield by
using covered interest arbitrage than by investing in U.S. Treasury bills? Explain.
ANSWER: If interest rate parity (IRP) existed, the forward rate of the euro should have a discount
reflecting the interest rate differential:
Forward discount = (1 + 11%) – 1 = –4.31% (discount)
(1 + 16%)
15. Diversified Investments. Hofstra, Inc., has no European business and has cash invested in six
European countries, each of which uses the euro as its local currency. Are Hofstra’s short-term
investments well diversified and subject to a low degree of exchange rate risk? Explain.
16. Investing Strategy. Should McNeese Co. consider investing funds in Latin America countries where it
may expand facilities? The interest rates are high and the proceeds from the investment could be used
to help support the investment. When would this strategy backfire?
17. Impact of September 11. Palos Co. commonly invests some of its excess dollars in foreign
government short-term securities in order to earn a higher short-term interest rate on its cash. Describe
how the potential return and risk of this strategy may have changed after the September 11, 2001
terrorist attack on the U.S.
Advanced Questions
18. Investing in a Portfolio. Pittsburgh Co. plans to invest its excess cash in Mexican pesos for one year.
The one-year Mexican interest rate is 19%. The probability of the peso’s percentage change in value
during the next year is shown below:
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International Cash Management 5
Possible Rate of Change
in the Mexican Peso Over Probability of
the Life of the Investment Occurrence
–15% 20%
–4% 50%
0% 30%
What is the expected value of the effective yield based on this information? Given that the U.S. interest
rate for one year is 7%, what is the probability that a one-year investment in pesos will generate a
lower effective yield than could be generated if Pittsburgh Co. simply invested domestically?
ANSWER:
Effective Yield if this
19. Effective Yield of Portfolio. Ithaca Co. considers placing 30% of its excess funds in a one-year
Singapore dollar deposit and the remaining 70% of its funds in a one-year Canadian dollar deposit.
The Singapore one-year interest rate is 15%, while the Canadian one-year interest rate is 13%. The
possible percentage changes in the two currencies for the next year are forecasted as follows:
Possible % Change in Probability of that
the Spot Rate Over Change in the Spot
Currency the Investment Horizon Rate Occurring
Singapore dollar –2% 20%
Singapore dollar 1% 60%
Singapore dollar 3% 20%
Canadian dollar 1% 50%
Canadian dollar 4% 40%
Canadian dollar 6% 10%
Given this information, determine the possible effective yields of the portfolio and the probability
associated with each possible portfolio yield. Given a one-year U.S. interest rate of 8%, what is the
probability that the portfolio’s effective yield will be lower than the yield achieved from investing in the
U.S.?
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International Cash Management 6
CRITICAL THINKING
Optimal Use of Cash in Foreign Countries Some U.S.-based MNCs have been maintaining a very large
amount of cash in foreign countries, because they would be subject to a corporate income tax on these
funds if they were remitted to the parent. The tax is implemented to cover the difference between the
corporate tax rate imposed by the U.S. government and the tax rate imposed by the foreign country. In
recent years, short-term interest rates in many countries have been very low, although not as low as in the
United States. Write a short essay to explain whether the low interest rates may cause MNCs to make
better use of their funds. What is an obvious alternative use of funds in a foreign country that an MNC
would likely consider? Why might the MNC continue to just maintain funds in cash accounts (earning very
low interest) rather than using the funds in a manner that could earn a higher expected return?
ANSWER
MNCs could possibly earn a higher return by using the cash in the foreign country to invest in corporate
projects, such as expanding their business operations. However, MNCs might only consider such a strategy
Solution to Continuing Case Problem: Blades, Inc.
1. There is a tradeoff between the higher interest rates in Thailand and the delayed conversion of baht into
dollars. Explain what this means.
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International Cash Management 7
2. If the net baht received from the Thailand subsidiary are invested in Thailand, how will U.S. operations
be affected?
3. Construct a spreadsheet that compares the cash flows resulting from two plans. Under the first plan,
net baht-denominated cash flows (received today) will be invested in Thailand at 15 percent for a one-
year period, after which the baht will be converted to dollars. Under the second plan, net baht-
denominated cash flows are converted to dollars immediately and 60 percent of the funds will be used
to support U.S. operations, while 40 percent are invested in the U.S. for one year at 8 percent. Which
plan is superior given the expectation of the baht’s value in one year?
ANSWER: (See spreadsheet attached.) The cash flow generated in one year if the funds are invested in
Thailand exceed the cash flows generated if the funds are remitted back to the U.S. today and invested
for one year at 8 percent by $1,742. Thus, it appears that Blades should invest the funds in Thailand
for one year and borrow the amount necessary to support its U.S. operations in the U.S. at an interest
rate of 10 percent.
Plan 1—Invest Funds in Thailand
Calculation of baht-denominated revenues:
Price per pair of "Speedos" THB 5,000
× Pairs of "Speedos" 120,000
= Baht-denominated revenues THB 600,000,000
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International Cash Management 8
Solution to Supplemental Case: Islander Corporation
a. By using a spreadsheet format, the percentage changes in exchange rates can be easily computed for
each scenario. Using these percentage changes along with the interest rates, the effective yield can be
computed for each currency under each scenario. The effective yields are provided below for each
scenario, along with the expected value of the effective yield (using the probabilities assigned to each
scenario):
Somewhat Expected Value
Strong $ Stable $ Weak $ of Effective
Currency Scenario Scenario Scenario Financ ing Rate
Australian dollar –0.56% 14.51% 28.07% 14.05%
British pound 4.56 14.48 21.10 13.49
Canadian dollar 9.71 9.71 17.45 12.03
Japanese yen –1.00 11.60 29.60 13.22
U.S. dollar 9.00 9.00 9.00 9.00
Based on the expected values of effective yields for the currencies, the optimal composition of each
portfolio is disclosed in the following table:
Percentage of Funds Invested in:
Type of Portfolio A$ BP C$ JY US$
Risk neutral 100 0 0 0 0
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International Cash Management 9
Balanced 25 25 25 25 0
Conservative 10 10 10 10 60
Ultra-conservative 0 0 0 0 100
The effective yields for each portfolio can be determined on the spreadsheet by creating a compute
statement that sums weighted effective yields based on the weights assigned above. These yields are
disclosed below:
Portfolio’s Effective
Yield Under a: Expected Value
Strong $ Stable $ Weak $ of Effective
Portfolio Scenario Scenario Scenario Financing Rate
Risk neutral –0.56% 14.15% 28.07% 14.05%
Balanced 3.18 12.58 24.06 13.20
Conservative 6.67 10.43 15.02 10.68
Ultra-conservative 9.00 9.00 9.00 9.00
Small Business Dilemma
Cash Management at the Sports Exports Company
1. If Logan invests the excess cash in U.S. Treasury bills, would this reduce the firm’s exposure to
exchange rate risk?
2. Logan decided to use the excess cash to pay off the British loan. However, a friend advised him to
invest the cash in British Treasury bills, stating that “the loan provides an offset to the pound
receivables, so you would be better off investing in British Treasury bills than paying off the loan.” Is
his friend correct? What should Logan do?
Part 5—Integrative Problem
Short-Term Asset and Liability Management
Kent Company is a large U.S. firm with no international business. It has two branches within the U.S., an
eastern branch and a western branch. Each branch presently makes investing or financing decisions
independently, as if it was a separate entity. The East branch has excess cash of $15 million to invest for
the next year. It can invest its funds in Treasury bills denominated in dollars or any of four foreign
currencies. The only restriction enforced by the parent is that a maximum of $5 million can be invested or
financed in any single foreign currency.
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International Cash Management 10
The western branch needs to borrow $15 million over one year to support its U.S. operations. It can
borrow funds in any of these same currencies (although any foreign funds borrowed need to be converted to
dollars to finance the U.S. operations). The only restriction enforced by the parent is that a maximum
equivalent of $5 million can be borrowed in any single currency.
A large bank serving the international money market has offered Kent Company the following terms:
Currency
Annual Interest
Rate on Deposits
Annual Interest Rate
Charged on Loans
U.S. dollar 6% 9%
Australian dollar 11 14
Canadian dollar 7 10
New Zealand dollar 9 12
Japanese yen 8 11
Kent Company has created one-year forecasts of each currency (shown below) that can be used by the
branches in making their investing or financing decisions:
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