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A B C D E F G H I J K
12/10/2012
A multinational corporation is one that operates in two or more countries.
Firms expand into other countries:
To seek new markets.
(1) Currency differences
(2) Economic and legal differences
Euro
Swedish krona
Chapter 17. Mini Case for Multinational Financial Management
a. What is a multinational corporation? Why do firms expand into other countries?
b. What are the six major factors which distinguish multinational financial management from financial
management as practiced by a purely domestic firm?
c. Consider the following illustrative exchange rates.
(1) What is a direct quotation? What is the direct quote for euros?
1.2500
U.S. Dollars Required to
Buy One Unit of Foreign
Currency
Units of Foreign
Currency Required to
Buy One U.S. Dollar
With the growth in demand for exotic foods, Possum Products' CEO Michael Munger is considering
expanding the geographic footprint of its line of dried and smoked low-fat opossum, ostrich, and venison
jerky snack packs. Historically, jerky products have performed well in the southern United States, but there
are indications of a growing demand for these unusual delicacies in Europe. Munger recognizes that the
expansion carries some risk--Europeans may not be as accepting of opossum jerky as initial research
questions.
7.0000
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A B C D E F G H I J K
Target Price = 1.75$ x 1.5
A cross rate is the exchange rate between any two currencies not involving U.S. dollars. In practice, cross
rates are usually calculated from direct or indirect rates. That is, on the basis of U.S. dollar exchange rates.
(4) What is a cross rate? Calculate the two cross rates between euros and kronor.
(5) Assume Possum Products can produce a package of jerky and ship it to France for $1.75. If the firm
wants a 50 percent markup on the product, what should the jerky sell for in France?
Indirect quotations are the reciprocal of the direct quotation, and direct quotations are the reciprocal of the
indirect quotation.
From a U.S. perspective, the quotes in the first column are called direct quotes because they are number of
units of a foreign currency that can be purchased by 1 unit of the home currency.
(2) What is an indirect quotation? What is the indirect quotation for kronor (the plural of krona is kronor).
Indirect quotations are are the number of units of foreign currency that can be purchased with one unit of
(3) The euro and British pound usually are quoted as direct quotes. Most other currencies are quoted as
indirect quotes. How would you calculate the indirect quote for a euro? How would you calculate the direct
quote for a krona?
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2.0 euros = 2.0 x 8.7500 kronor/euro
2.0 euros = 17.50 kronor
Suppose the kronor per dollar exchange rate changes.
The current system is a floating rate system.
A currency is convertible when the issuing country promises to redeem the currency at current market rates.
d. Briefly describe the current international monetary system. How does the current system differ from the
system that was in place prior to August 1971?
e. What is a convertible currency? What problems arise when a multinational company operates in a country
whose currency is not convertible?
Exchange rate risk is the risk that the value of a cash flow in one currency translated from another currency
will decline due to a change in exchange rates.
(6) Now assume Possum Products begins producing the same package of jerky in France. The product
costs 2.0 euros to produce and ship to Sweden, where it can be sold for 20 kronor. What is the dollar profit
on the sale?
(7) What is exchange rate risk?
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A B C D E F G H I J K
A spot rate is the rate applied to buy currency for immediate delivery.
Example:
A U.S. investor could directly invest in the U.S. security and earn an annualized rate of 6%. Alternatively, the
U.S. investor could convert dollars to euros invest in the French security, and then convert profit back into
dollars. If the return on this strategy is higher than 6%, then the French security has the higher rate.
Interest rate parity implies that investors should expect to earn the same return on similar-risk securities in
all countries:
g. What is interest rate parity? Currently, you can exchange 1 euro for 1.2700 dollars in the 180-
day forward market, and the risk-free rate on 180-day securities is 6 percent in the United States
and 4 percent in France. Does interest rate parity hold? If not, which securities offer the highest
expected return?
f. What is the difference between spot rates and forward rates? When is the forward rate at a premium to the
spot rate? At a discount?
If interest rate parity holds, the computed forward rate would be the same as the observed forward rate, so
parity does not hold.
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A B C D E F G H I J K
French investment return (in euros):
800.00 x 1.02000
= 816.00 euros
Buy contract today to exchange euros in 180 days at forward rate.
k. To what extent do average capital structures vary across different countries?
j. Briefly discuss the international capital markets.
Purchasing power parity implies that the level of exchange rates adjusts so that identical goods cost the
same amount in different countries.
Lower inflation leads to lower interest rates, so borrowing in low-interest countries may appear attractive to
multinational firms. However, currencies in low-inflation countries tend to appreciate against those in high-
inflation rate countries, so the true interest cost increases over the life of the loan.
i. What impact does relative inflation have on interest rates and exchange rates?
This is higher than return on U.S. security, so French securities have higher returns after
adjusting for exchange rates.
h.What is purchasing power parity? If a package of jerky costs $2.00 a liter in the United States and
purchasing power parity holds, what should be the price of the jerky package in France?
Early studies suggested that average capital structures varied widely among the large industrial countries.
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A B C D E F G H I J K
Intital cost in million of yen = ¥1,000 ¥
Year 1 CF in yen = ¥500
Year 2 CF in yen = ¥800
Use the interest rate parity relationship to estimate the future expected exchange rates:
f t = e0 [(1+r h) / (1+r f)]t
Maturity (in
years)
rhrf
Spot rate
($/¥)
Expected
forward
rate ($/¥)
1 2.0% 0.05% 0.009091 0.009268
2 2.8% 0.26% 0.009091 0.009557
Distances are greater.
Access to more markets for loans and for temporary investments.
Cash is often denominated in different currencies.
Some factors to consider are shipping times, carrying costs, taxes, import duties, and exchange rates.
Inventory decisions can be more complex, especially when inventory can be stored in locations
in different countries.
(1) Cash management.
m. Briefly discuss special factors associated with the following areas of multinational working capital
management.
(2) Credit management.
(3) Inventory management.
l. Using the data below, evaluate a potential investment by a U.S. company in Japan.
