Chapter 17 Multinational Financial Management

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Multinational Financial Management

What is a multinational corporation?

  • A corporation that operates in two or more countries.

  • Decision making within the corporation may be centralized in the home country, or may be decentralized across the countries the corporation does business in.

Why do firms expand into other countries?

  • To seek new markets.

  • To seek raw materials.

  • To seek new technology.

  • To seek production efficiency.

  • To avoid political and regulatory hurdles.

  • To diversify.

Consider the following exchange rates

Direct Indirect

# of units of foreign

US $ to buy 1 unit currency per US $

Japanese yen 0.009 111.11

Australian dollar 0.650 1.5385

  • Are these currency prices direct or indirect quotations?

  • Since they are prices of foreign currencies expressed in dollars, they are direct quotations.

What is an indirect quotation?

  • The number of units of a foreign currency needed to purchase one U.S. dollar, or the reciprocal of a direct quotation.

  • Are you more likely to observe direct or indirect quotations?

  • Most exchange rates are stated in terms of an indirect quotation.

  • Except the British pound, which is usually in terms of a direct quotation.

  • Simply find the inverse of the direct quotations.




Swiss Franc .5728 1.7458

BRITISH POUND 1.6342 .6119

EURO 1.1203 .8926

Buy a Porsche for 200,000 S. Francs - How much in US $?

You want to convert $1000 into pounds. How many BP?

Convert $1000 into Euros. How many?

1 If British pounds sell for $1.50 (U.S.) per pound, what should dollars sell for in pounds per dollar?

2. Suppose that 1 Danish krone could be purchased in the foreign exchange market for 14 U.S. cents today. If the krone appreciated 10 percent tomorrow against the dollar, how many krones would a dollar buy tomorrow?

3. Suppose the exchange rate between the U.S. dollar and the Swedish krona was 10 krona = $1.00, and the exchange rate between the dollar and the British pound was £1 = $1.50. What was the exchange rate between Swedish kronas and pounds?

What is a cross rate?

Direct Indirect

# of units of foreign

US $ to buy 1 unit currency per US $

Japanese yen 0.009 111.11

Australian dollar 0.650 1.5385

  • The exchange rate between any two currencies. Cross rates are actually calculated on the basis of various currencies relative to the U.S. dollar.

  • Cross rate between Australian dollar and the Japanese yen.

  • Cross rate = (Yen / US Dollar) x (US Dollar / A. Dollar)

= 111.11 x 0.650

= 72.22 Yen / A. Dollar

  • The inverse of this cross rate yields:

0.0138 A. Dollars / Yen

Orange juice project:

Setting the appropriate price

  • A firm can produce a liter of orange juice and ship it to Japan for $1.75 per unit. If the firm wants a 50% markup on the project, what should the juice sell for in Japan?

Price = (1.75)(1.50)(111.11)

= 291.66 yen

Orange juice project:

What is exchange rate risk?

  • The risk that the value of a cash flow in one currency translated to another currency will decline due to a change in exchange rates.

  • For example, in the last slide, a weakening Australian dollar (strengthening dollar) would lower the dollar profit.

What is purchasing power parity (PPP)?

  • Purchasing power parity implies that the level of exchange rates adjusts so that identical goods cost the same amount in different countries.

  • Absolute Form PPP – Without international barriers consumers shift their demand to wherever prices are lower. The prices of the basket of products in two different should be equal when measured in a common currency.

  • Relative Form of PPP – Because of market frictions (tariffs, transportation costs and quotas) prices of the same basket of products in different countries will not necessarily be the same when measured in a common currency.

Spot Yen $.012/Yen

Lebron Basketball shoes cost $110 in USA (assume the shoes represents a basket of US goods). They should cost Yen in Japan

Suppose they cost 12,000 Yen in Japan. If Absolute PPP holds what should happen?



BRITISH POUND 1.6342 .6119

4. A television set costs $500 in the United States. The same set costs 725 euros. If purchasing power parity holds, what is the spot exchange rate between the euro and the dollar?

European Monetary Union

  • In 1999, the implementation of the “euro” occurred. The national currencies of the 11 participating countries were phased out in favor of the “euro.” The newly formed European Central Bank controls the monetary policy of the EMU. (now 16 countries use the Euro and 27 countries in the EMU)

The euro (January 4, 1999) is the official currency of the European Union, and is currently in use in 17 of the 27 Member States (11 countries originally used it). The states, known collectively as the Eurozone are Austria, Belgium, Cyprus, Estonia, Finland, France, Germany, Greece, Ireland, Italy, Luxembourg, Malta, the Netherlands, Portugal, Slovakia, Slovenia and Spain.




S Franc (SPOT) .5728 1.7458

1 MONTH .5718 1.7489

2 MONTHS .5709 1.7516

6 MONTHS .5671 1.7634

Two Types of Transactions

1. Spot Market - Exchange currency on the spot - trade settled within 2 business days.

2. Forward Market - Forward trade is an agreement to exchange currency at some time in the future.





RATE - USA = 1% + 1% = 2%


RATE = 1% + 3% = 4%

S. Franc

* Difference in risk free rates between countries is approximately the difference in inflation rates in the two countries

* Inflation is 2% higher in the Switzerland than in the USA and the Risk Free Rate is 2% higher as well.


Exchange rates in the forward market is different than the spot rate due to

- differences in the risk free rate

of the two countries

- differences in expected inflation

in the two countries

Predicting Forward Exchange Rates

One Year Forward = $ .5728/SF * 1.02/1.04

= One Year Forward

Exchange Rate

= $ .5618/SF

What is interest rate parity?

  • Interest rate parity holds that investors should expect to earn the same return in all countries after adjusting for risk.

What impact does relative inflation have on interest rates and exchange rates?

  • 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 effective interest cost increases over the life of the loan.

When is the forward rate at a premium to the spot rate?

  • 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.

  • In the opposite situation, the foreign currency is selling at a discount.

The primary determinant of the spot/forward rate relationship is relative interest rates

5. Chamberlain Canadian Imports has agreed to purchase 15,000 cases of Canadian beer for 4 million Canadian dollars at today's spot rate. The firm's financial manager, James Churchill, has noted the following current spot and forward rates:

U.S. Dollar/Canadian Dollar Canadian Dollar/U.S. Dollar

Spot 1.0526 .9500

30-day forward 1.0504 .9520

90-day forward 1.0471 .9550

180-day forward 1.0444 .9575
On the same day, Churchill agrees to purchase 15,000 more cases of beer in 3 months at the same price of 4 million Canadian dollars.

a. What is the price of the beer, in U.S. dollars, if it is purchased at today's spot rate?

b. What is the cost, in U.S. dollars, of the second 15,000 cases if payment is made in 90 days and the spot rate at that time equals today's 90-day forward rate?

c. If the exchange rate for the Canadian dollar is.90 to $1 in 90 days, how much will Churchill have to pay for the beer (in U.S. dollars)?

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