Chapter 21
International Cash Management
Lecture Outline
Multinational Working Capital Management
Subsidiary Expenses
Complications in Optimizing Cash Flows
Investing Excess Cash
Benefits from Investing in a Foreign Currency
Risk f Investing in a Foreign Currency Hedging the Investment in a Foreign Currency
Break-even Point from Investing in a Foreign Currency
Using a Probability Distribution to Enhance the Investment Decision
Dynamic Hedging
International Cash Management ❖ 2
Chapter Theme
This chapter emphasizes the decisions involved in the management of cash by an MNC. The additional
opportunities and risks of cash management for an MNC versus a domestic firm should be stressed.
There are actually three key components of the chapter. The first is distinguishing between subsidiary
control over excess cash versus centralized control. An argument is made in favor of centralized control.
The second component is optimizing cash flow. Several techniques are recommended to optimize cash
flow. Finally, the decision of where to invest excess cash should be discussed with consideration of all
factors that need to be incorporated for this decision.
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?
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.
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Answers to End of Chapter Questions
1. International Cash Management. Discuss the general functions involved in international cash
management. Explain how an MNC can optimize cash flows.
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.
2. Netting. Explain the benefits of netting. How can a centralized cash management system be
beneficial to the MNC?
ANSWER: Netting is a centralized compilation of inter-subsidiary cash flows. It is designed to
reduce currency conversion costs and processing costs associated with payments between
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%
International Cash Management ❖ 4
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ANSWER: If the peso depreciates by more than 31.875 percent, the effective yield on the Mexican
deposit will be less than the domestic yield.
6. Investing Strategy. Why would a U.S. firm consider investing its 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?
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
1/2% on a Mexican deposit. The spot rate of the Mexican peso is $.12, and 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? Support your
answer.
9. Effective Yield. Rollins, Inc., has $3 million in cash available for 1 year. It can earn 3% on a U.S.
Treasury bill or 5% on a British Treasury security. The British investment does require conversion of
the company’s dollars to British pounds. Assume that interest rate parity holds and that Rollins
believes the 1-year forward rate is a reliable predictor of the spot rate to be realized 1 year from now.
Would the British investment provide an effective yield that is less than, greater than, 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 1 year forward
rate of the pound to substantially overestimate the spot rate to be realized in 1 year.
11. Effective Yield. Repeat question 9, but this time assume that Rollins, Inc., expects the 1-year forward
rate of the pound to substantially underestimate the spot rate to be realized in 1 year.
International Cash Management ❖ 5
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permitted in a license distributed with a certain product or service or otherwise on a password-protected website for classroom use.
ANSWER: In this case, Rollins Inc. will receive more when converting the pounds back to dollars
than the amount necessary to match the domestic return. Thus, the foreign return is expected to be
greater than the domestic return.
12. Effective Yield. Assume that the one-year U.S. interest rate is 2% and the one-year Canadian interest
rate is 5%. 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?
14. Interest Rate Parity. Dallas Co. has determined that the interest rate on euros is 6 percent while the
U.S. interest rate is 3 percent for one-year Treasury bills. The one-year forward rate of the euro has a
discount of 5 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:
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 in this region and the proceeds from the
investment could be used to help support the investment. When would this strategy backfire?
International Cash Management ❖ 6
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permitted in a license distributed with a certain product or service or otherwise on a password-protected website for classroom use.
ANSWER: McNeese could benefit from investing at a high interest rate. However, this strategy could
backfire if the currency weakens over time, because McNeese Co. could have converted dollars later
(at the time of expansion) at a more favorable exchange rate. The tradeoff is a higher interest rate if it
invests funds now, versus a more favorable exchange rate if it invests funds later.
17. Impact of September 11. Palos Co. commonly invests some of its excess dollars in foreign
government’s short-term securities in an effort 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:
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 its funds
domestically?
ANSWER:
Effective Yield if this
Possible Rate of Rate of Change in the
Change in Peso Probability Peso Does Occur
–15% 20% (1.19) [1 + (–15%)] – 1 = 1.15%
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.
International Cash Management ❖ 7
The Singapore one-year interest rate is 15%, and 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.?
ANSWER:
Possible % Change Effective Yield Based on the
in the Singapore Dollar % Change in the Singapore Dollar
–2% (1.15) [1 + (–2%)] – 1 = 12.7%
Possible % Change in Effective Yield Based on the
the Canadian Dollar % Change in the Canadian Dollar
1% (1.13) [1 + (1%)] – 1 = 14.13%
Possible Joint
Effective Yield Computation of Computation of Effective
S$ C$ Joint Probability Yield of Portfolio
12.7% 14.13% (20%)(50%) = 10% .3(12.7%) + .7(14.13%) = 13.701%
12.7 17.52 (20%)(40%) = 8% .3(12.7%) + .7(17.52%) = 16.074%
CRITICAL THINKING
Optimal Use of Cash in Foreign Countries Some foreign subsidiaries maintain cash in local bank
International Cash Management ❖ 8
accounts that earns very low interest rates. If they invested the money to expand, they would likely have
earned a higher return. Write a short essay that either criticizes or defends a subsidiary’s decision to
maintain funds as deposits rather than expand its business.
ANSWER
MNCs could possibly earn a higher return by using the cash in the foreign country to invest in corporate
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.
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 will be converted to dollars immediately and 60 percent of the funds will be
used to support U.S. operations, while 40 percent will be invested in the U.S. for one year at 8
percent. Which plan is superior given the expectation for the baht’s value in one year?
ANSWER: (See spreadsheet attached.) The cash flow generated in one year if the funds are invested
Plan 1—Invest Funds in Thailand
Calculation of baht-denominated revenues:
Price per pair of “Speedos”
THB 5,000
× Pairs of “Speedos”
120,000
International Cash Management ❖ 9
= Baht-denominated revenues
THB 600,000,000
Repayment of baht-denominated loan:
Principal
THB 420,000,000
+ Interest (420,000,000 × .06)
THB 25,200,000
= Baht-denominated outflow
THB 445,200,000
Calculation of interest on U.S. dollar loan needed to support U.S. operations:
Dollar receipts if baht were remitted now:
Net baht-denominated cash flows available (600,000,000 – 445,200,000)
THB 154,800,000
Spot rate of baht
$ 0.0225
Amount of dollars received if baht were converted today
$ 3,483,000
Amount of dollar to be borrowed because funds are not converted today
($3,483,000 × 60%)
$ 2,089,800
Interest paid on U.S. dollar loan ($2,089,800 × 10%)
$ 208,980
Calculation of dollar receipts due to conversion of baht into dollars in one year:
Net baht-denominated cash flows available (600,000,000 – 445,200,000)
THB 154,800,000
Interest earned on baht over a one-year period (15%)
THB 23,220,000
Baht to be converted in one year
THB 178,020,000
× Expected spot rate of baht in one year ($0.0225 × 0.95)
$ 0.021375
= Expected dollar receipts in one year
$ 3,805,178
Less: Interest paid on U.S. dollar loan
$ 208,980
= Net dollar receipts in one year
$ 3,596,198
Plan 2—Convert Funds Immediately
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
Repayment of baht-denominated loan:
Principal
THB 420,000,000
+ Interest (420,000,000 × .06)
THB 25,200,000
= Baht-denominated outflow
THB 445,200,000
Calculation of dollar receipts due to conversion of baht into dollars:
Net baht-denominated cash flows available (600,000,000 – 445,200,000)
THB 154,800,000
× Spot rate of baht now
$ 0.0225
= Dollar receipts now
$ 3,483,000
Amount of dollars invested in the U.S. ($3,483,000 × 40%)
$ 1,393,200
Interest earned on dollar investment in the U.S. ($1,393,200 × 8%)
$ 111,456
= Dollar receipts in one year
$ 3,594,456
Calculation of dollar difference between the two plans:
Plan 1
$ 3,596,198
Plan 2
3,594,456
Dollar difference
$ 1,742
International Cash Management ❖ 10
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 Financing Rate
Australian dollar –0.56% 14.51% 28.07% 14.05%
British pound 4.56 14.48 21.10 13.49
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
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%
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 his firm’s exposure to
exchange rate risk?
International Cash Management ❖ 13
5. What is the expected effective financing rate of the total amount of funds borrowed?
ANSWER: Based on 33.3% financed with each of three currencies (C$, U.S.$, A$), the expected
financing rate for the entire portfolio of funds borrowed is:
6. Based on the expected effective financing rate for the portfolio and the total amount of $15 million
borrowed, determine the expected loan repayment amount beyond the principal borrowed.
ANSWER: The expected loan repayment amount beyond the principal borrowed is the portfolio’s
expected effective financing rate times the amount borrowed, or:
7. When the expected interest received by the eastern branch and paid by the western branch of Kent
Company are consolidated, what is the net amount of interest received?
ANSWER:
Net = Interest received – Interest paid
8. If the eastern branch and western branch worked together, the eastern branch could loan its $15
million to the western branch. Nevertheless, one could argue that the branches could not have taken
advantage of interest rate differentials or expected exchange rate effects among currencies. Given the
data provided in this example, would you have recommended that the two branches make their short-
term investment and financing decisions independently, or should the eastern branch lend its excess
cash to the western branch? Explain.
ANSWER: If one branch lends to another, the interest received by one branch will be exactly equal
to the interest paid by the other. Yet, the expected interest received is $28,500 above the expected
International Cash Management ❖ 14
avoid a substantial amount of exchange rate risk, especially because the firm did not have any
international business that could offset foreign investment or financing positions.
DISCUSSION IN THE BOARD ROOM
This exercise is intended to apply many of the key concepts to broad issues that are discussed by
managers who make financial decisions. It does not replace the more detailed questions and problems at
the end of the chapter. Instead, it focuses on broad financial issues to facilitate class discussion and
simulate a board room discussion. It serves as a running case in which broad concepts from every chapter
are applied to the same business throughout the school term. The exercise not only enables you to apply
concepts to the real world, but also develops your intuitive and communication skills.
There are several alternative ways in which this exercise is used in a course.
2. Use it to encourage online discussion for courses taught online.
4. Use it as a comprehensive case discussion near the end of the semester, as a means of reviewing the
key concepts that were described throughout the course.
5. Use it for presentations, in which individuals or teams present their views on the questions that were
assigned to them.
BACKGROUND
One of the best methods of learning broad concepts in this text is to put yourself in the place of an MNC
manager or board member and apply the concepts to make financial decisions. Board members do not
normally make the decisions that are discussed here but must have the conceptual skills to monitor the
policies that are implemented by the MNC’s managers. Thus, they must frequently ask themselves what
they would do if they were making the managerial decisions or setting corporate polices.
Consider the following business that you could easily create: a business that teaches individuals in a non-
International Cash Management ❖ 15
You also serve some individuals from Mexico who have taken English classes and want to come to the
U.S. for a one-week intense course in which they can improve and practice their English and practice it.
All revenue and expenses associated with your business are denominated in Mexican pesos. Most of the
Chapter 1
a. Discuss the corporate control of your business. Explain why your business in Mexico is exposed
to agency problems.
b. How would you attempt to monitor the ongoing operations of the business?
c. Explain how you might be able to use a compensation plan that limits the potential agency
problems?
d. Assume that you have been approached by a competitor in Mexico to engage in a joint venture.
The competitor would offer the classroom facilities (so that you would not need to rent classroom
facilities), while your employees would provide the teaching. You would split the profits with this
business. Discuss how your potential return and your risk would change if you pursue the joint
venture.
e. Explain the conditions that would cause your business to be adversely affected by exchange rate
movements.
f. Explain how your business could be adversely affected by political risk.
ANSWER:
a. Agency problems could exist, because the employees of your business in Mexico may not make
an effort to achieve growth in the business, or to perform their jobs properly. It may be difficult