(2) Economic and legal differences
(3) Language differences
(4) Cultural differences
(5) Government roles
(6) Political risk
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1/15/2015
A multinational corporation is one that operates in two or more countries.
Firms expand into other countries:
To seek new markets.
(1) Currency differences
Chapter 27. 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.
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
home currency (the home currency is the U. S. Dollar in this example).
rates are usually calculated from direct or indirect rates. That is, on the basis of U.S. dollar exchange rates.
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Euro
Swedish krona
Cross rate between kronor and euros (Euro per krona) is recipical of krona per euro cross rate:
Cross Rate = SEK/EUR = 1÷EUR/SEK
A cross rate is the exchange rate between any two currencies not involving U.S. dollars. In practice, cross
(1) What is a direct quotation? What is the direct quote for euros?
(4) What is a cross rate? Calculate the two cross rates between euros and kronor.
1.2500
7.0000
Indirect quotations are the reciprocal of the direct quotation, and direct quotations are the reciprocal of the
indirect quotation.
(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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Target Price = 1.75$ x 1.5
2.0 euros = 2.0 x 8.7500 kronor/euro
Suppose the kronor per dollar exchange rate changes.
The current system is a floating rate system.
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?
(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?
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?
If the U.S. dollar buys fewer units of a foreign currency in the forward than in the spot market, the foreign
currency is selling at a premium.
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A currency is convertible when the issuing country promises to redeem the currency at current market rates.
e. What is a convertible currency? What problems arise when a multinational company operates in a country
whose currency is not convertible?
Interest rate parity implies that investors should expect to earn the same return on similar-risk securities in all
countries:
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?
It becomes very difficult for multi-national companies to conduct business because there is no easy way to
take profits out of the country.
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Implied Direct Forward Rate = 1.2623
Example:
Buy $1,000 worth of euros in the spot market:
Dollars x Spot Indirect Quote (euros/dollar)
At end of 180 days, convert euro investment to dollars:
816.00 x 1.27000 dollars per euro
= $ 1,036.32
Calculate the rate of return:
A U.S. investor could directly invest in the U.S. security and earn an annualized rate of 6%. Alternatively, the
Purchasing power parity implies that the level of exchange rates adjusts so that identical goods cost the same
amount in different countries.
i. What impact does relative inflation have on interest rates and exchange rates?
h.What is purchasing power parity? If a package of jerky costs $2.00 a liter in the United States and
purchasing power parity holds, what should be the price of the jerky package in France?
If interest rate parity holds, the computed forward rate would be the same as the observed forward rate, so
parity does not hold.
However, a recent study, which controlled for differences in accounting practices, suggests that capital
structures are more similar across different countries than previously thought.
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Eurodollar markets
k. To what extent do average capital structures vary across different countries?
Intital cost in million of yen = ¥1,000 ¥
Year 1 CF in yen = ¥500
Use the interest rate parity relationship to estimate the future expected exchange rates:
Maturity (in
years)
rhrf
Spot rate
($/¥)
Expected
forward
rate ($/¥)
0 1 2
Cash flows
in yen
-¥1,000 ¥500 ¥800
j. Briefly discuss the international capital markets.
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.
Year
l. Using the data below, evaluate a potential investment by a U.S. company in Japan.
Early studies suggested that average capital structures varied widely among the large industrial countries.
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Distances are greater.
Credit is more important, because commerce to lesser-developed countries often relies on credit.
Inventory decisions can be more complex, especially when inventory can be stored in locations
(1) Cash management.
m. Briefly discuss special factors associated with the following areas of multinational working capital
management.
(2) Credit management.
(3) Inventory management.