C H A P T E R 1 6
International financial management
Chapter objectives
2. Study some of the most common techniques that are used in managing global cash flows,
including funds positioning and multilateral netting.
4. Explain how capital budgeting is carried out in a multinational firm.
6. Provide examples of international financial strategies currently being used by
multinationals.
Chapter summary
1. International financial management encompasses a number of critical areas, including the
management of global cash flows, foreign exchange risk management, capital expenditure
2. There are three main areas of consideration in managing global cash flows. One is the
movement of cash so that each subsidiary has the working capital needed to conduct
3. Foreign exchange risk management encompasses a variety of financial strategies that are
designed to limit a multinationals exposure to exchange rate fluctuations. In particular, the
4. A third major strategic financial issue is capital expenditure analysis. This entails
computation and deliberation of such matters as the weighted cost of capital and the degree
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5. Firms must ensure that the financial structure of the home office and its subsidiaries satisfies
investors. They must also constantly evaluate their financial performance to determine
whether financial plans were met and to adjust expectations.
Chapter outline
Introduction
Determining parentsubsidiary relationships
Polycentric solution
Ethnocentric solution
Geocentric solution
Managing global cash flows
Internal funds flows
Funds positioning techniques
Exchange risk management
Transaction risk
Translation risk
Economic risk
An example of exchange risk management
Developing forecasting and reporting systems
Capital budgeting in the MNE
Use of NPV
Institutional features
International financing in the MNE
Financial structure
Rugman and Collinson, International Business, 6th edition, Instructor’s Manual
Control: Identifying objectives, evaluating affiliate performance and making performance
consistent with goals
Strategic international finance
Establishing overseas operations
Reducing financial risk
Alliances
Cost cutting
Lecture outline
A. Introduction
1. International financial management encompasses a number of key areas. These include
2. The objective of international financial management strategies is to provide assistance
B. Determining parentsubsidiary relationships
1. Because finance is so important an area of operations, it is critically important that
2. A polycentric solution is to treat the MNE as a holding company and to decentralize
decision making to the subsidiary levels. The advantages of this approach include the
3. An ethnocentric solution is to treat all foreign operations as if they are extensions of
domestic operations. The advantage of this system is that management is able to
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4. A geocentric solution is to handle financial planning and controlling decisions on a
global basis. These decisions are typically influenced by two factors. One is the nature
C. Managing global cash flows
1. One of the key areas of international financial management is the careful handling of
2. When an MNE wants to expand operations or fund activities, one of the simplest ways
of obtaining the needed monies is by getting them from internal sources such as
3. Funds positioning techniques are strategies used to move monies from one multinational
4. A transfer price is an internal price that is set by a company in intrafirm trade. While
these prices are supposed to be set at arms length, by raising or lowering them an MNE
5. A second funds positioning technique is the use of tax havens, which are low-tax
countries that are hospitable to business. This strategy is typically used in conjunction
6. A fronting loan is a funds positioning strategy that involves having a third party manage
7. Multilateral netting, which involves a determination of the net amount of money owed
to subsidiaries through multilateral transactions, begins with a computation of the
8. There are a number of reasons why multilateral netting has become popular. One is that
it helps the parent company ensure that financial interactions between the units are
9. There are also some problems associated with multilateral netting. One is that many
governments place controls on these operations by allowing them only for trade
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10. Viewing the company as a single unit for the purposes of cash management can yield
far better results than would be obtained if each affiliate managed its cash
independently. For example, much less foreign exchange protection is generally needed
if all of the affiliates are evaluated together, rather than if each affiliate hedges its own
D. Exchange risk management
1. There are a number of areas that merit attention in examining foreign exchange risk
2. Transaction exposure is the risk that a firm faces when paying bills or collecting
receivables in the face of changing exchange rates.
3. Translation is the process of restating foreign financial statements in the currency of the
parent company. In this way, management and the stockholders can see how each unit is
doing. The company will also combine the major financial statements of subsidiaries
4. Translation exposure is the foreign exchange risk that a firm faces when translating
5. Economic exposure is the foreign exchange risk involved in pricing products, sourcing
parts or locating investments to develop a competitive position. Economic exposure
covers a wide gamut of risk. In the case of pricing products, when the currency of a
foreign buyer changes in relation to that of the seller, the latter has to decide how to deal
with the accompanying risk. A related decision deals with subsidiary assets. If the value
Rugman and Collinson, International Business, 6th edition, Instructor’s Manual
6. A hedge is a form of protection against an adverse movement of an exchange rate. If a
multinational would suffer a large financial loss if the dollar were to weaken against the
7. In fact, all three kinds of foreign exchange risk play important parts in the management
of an international firm. No single hedging strategy can cover them all, so the MNE
E. Capital budgeting in the MNE
1. Capital expenditures are major projects in which the costs are to be allocated over a
number of years. In contrast to domestic projects, one basic question must be answered:
who should conduct the analysis, the parent or the foreign subsidiary? Typically, the
2. In examining what determines the net present value (NPV), it is important to realize that
disagreements between the parent and subsidiary can arise because of the discount rate
3. There are two institutional factors that warrant attention: government subsidies and
controls, and political risk insurance. Government intervention can affect the
F. International financing in the MNEs
1. The home office of an MNE should have available to it funding from the domestic
money and capital markets, as well as from international money and capital markets.
2. Financial structure in a multinational enterprise is complicated by the fact that the
G. Control: Identifying objectives, evaluating affiliate performance and making performance
consistent with goals.
1. Control is the fundamental function of management that involves developing profit
plans for the firm and its divisions and then deciding what to do when actual operating
results differ from those planned. For a foreign investment project, the financial control
2. Evaluation of the performance of managers of foreign affiliates must take into
consideration exchange risk and the constraints placed upon the subsidiary. For
H. Strategic international finance
1. There are a number of ways in which MNEs apply the international financial concepts
that have been discussed in this chapter. One way is by employing a geocentric
2. Because the United States is a major market for many international firms, foreign MNEs
have been particularly concerned about the value of the US dollar. The MNEs with
3. While some of the above strategies are useful in reducing risk, other tactics are also
particularly useful, including mergers, acquisitions, joint ventures for new, high-risk
Rugman and Collinson, International Business, 6th edition, Instructor’s Manual
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Answers to review and discussion questions
1. In determining parentsubsidiary relationships, how does a polycentric solution differ
from an ethnocentric or geocentric solution? Compare and contrast all three.
2. What is meant by the term working capital, and what are two of the most common
ways that parent companies can provide this capital to their subsidiaries? What are
two ways in which the parent can obtain funds from the subsidiaries?
3. How can an MNE shift profits through the use of transfer pricing? Provide an
example.
An MNE can shift profits by having one subsidiary charge another a very high price, thus
4. Of what value is multilateral netting in helping MNEs to manage cash flows? Give an
example.
5. If a foreign country is facing high inflation, what are three financial strategies that the
local multinational unit might employ? Identify and describe each.
One of the strategies that the local MNE might employ is to depreciate its fixed assets rapidly,
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6. Why are MNEs interested in the translation and consolidation of financial statements?
Of what practical value is this activity to the company?
7. Under what conditions will an MNE face translation exposure? What financial
strategy might the organization use to minimize this exposure?
8. When might an MNE face transaction exposure? What is a financial strategy that the
firm could use to minimize this risk?
9. What is meant by the term economic exposure? What is a financial strategy that an
MNE could use to minimize this risk?
10. When would a multinational use a lead strategy to hedge a risk? When would a
multinational use a lag strategy for this purpose? In each case, give an example. A lead
strategy is a choice by an MNE to make intracompany payments (for example, from
an affiliate to the home office) earlier than in an arms-length situation, to move funds
out of the country of the affiliate more rapidly. A lag strategy is a choice by an MNE to
make intracompany payments (for example, from an affiliate to the home office) later
than in an arms-length situation, to hold funds longer in the affiliate country.
An MNE would use a lead strategy to hedge a risk when a foreign-currency receivable is
11. When might an MNE use a forward exchange contract (a contract with a bank to buy
or sell foreign exchange at a future date, with the exchange rate and value fixed
today)? When might the firm decide to forgo this strategy and leave a particular
foreign currency transaction unhedged?
12. What role does net present value (NPV) play in the review of capital expenditure
proposals? Give an example.
13. How can country risk affect the computation of NPV? Will the risk result in the MNE
wanting a higher or a lower NPV? Explain.
14. Why do parent and local subsidiaries sometimes differ in their calculation of NPV for
a particular project or expenditure? How can this difference be resolved?
15. What are some of the financing alternatives available to MNEs that are not available
to domestic firms? Give an example.
Rugman and Collinson, International Business, 6th edition, Instructor’s Manual
Answers to real cases
Skandia
1. Why has insurance changed from local salespeople to an Internet-provided
universal product?
2. Why was Swedish-based Skandia so successful in the US market?
3. Was CEO Jan Carendi Swedish or global in his management style?
Repsols acquisition of YPF
1. Did Repsol make a good decision in acquiring YPF in 19981999?
2. What is the difference between foreign direct investment and foreign portfolio
investment? Is this a relevant issue in the case?
3. What are American Depositary Receipts? Were they a useful tool for YPF in selling
shares to the public?