CH19

Chapter 19
Multinational Financial
Management
 Multinational vs. Domestic Financial
Management
 Exchange Rates and Trading in
Foreign Exchange
 International Money and Capital
Markets
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 in which the
corporation does business.
Dr. Saad Alnahedh - College of Business Administration - Kuwait University 2

Why do firms expand into other
countries?
1. To seek production efficiency.
2. To avoid political and regulatory hurdles.
3. To seek new markets.
4. To seek raw materials and new technology.
5. To protect processes and products.
6. To diversify.
7. To retain customers.

Multinational Financial Management vs.
Domestic Financial Management
1. Different currency denominations.

2. Political risk
3. Economic and legal ramifications.
4. Role of governments
5. Language and cultural differences.

Consider the Following Exchange Rates
US $ to Buy 1 Unit
Japanese yen 0.009
Australian dollar 0.650
 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.

Calculate the Indirect Quotations for
Yen and Australian Dollars
# of Units of Foreign
Currency per US $
Japanese yen 111.11
Australian dollar 1.5385
 Simply find the inverse of the direct

quotations.

What is a cross rate?
 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 = ($1.75)(1.50)(111.11 yen/$)
= 291.66 yen

Orange Juice Project:
Determining Profitability
 The product will cost 250 yen to produce and
ship to Australia, where it can be sold for 6
Australian dollars. What is the U.S. dollar
profit on the sale?
Cost in A. dollars  250 yen(0.0138)
 3.45 A. dollars
A. dollar profit  6  3.45  2.55 A. dollars
U.S. dollar profit  2.55/1.5385  $1.66

 Problem 19-1
EXCHANGE RATE
If British Pounds sell for $1.67 (US) per pound, what should the dollars sell for in pounds per dollar?
Dr. Saad Alnahedh - College of Business Administration - Kuwait University

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.

International Monetary System
 The framework within which exchange rates

are determined.
 The blueprint for international trade and capital
flows.
 Exchange rate terminology
 Spot vs. forward exchange rate
 Fixed vs. floating exchange rate
 Devaluation and revaluation
 Depreciation and appreciation
 Problem 19-7
CURRENCY APPRECIATION
Suppose that 1 Danish krone could be purchased in the foreign exchange market today for $0.18. If
the krone appreciated 10% tomorrow against the dollar, how many krones would a dollar buy
tomorrow?

 Problem 19-14
EXCHANGE GAINS AND LOSSES
You are the vice president of International InfoXchange, headquartered in Chicago, Illinois. All
shareholders of the firm live in the United States. Earlier this month you obtained a loan of 5 million
Canadian dollars from a bank in Toronto to finance the construction of a new plant in Montreal. At
the time the loan was received, the exchange rate was $0.92 to the Canadian dollar. By the end of
the month, it has unexpectedly dropped to $0.82. Has your company made a gain or a loss as a
result, and by how much?

Floating Monetary Agreements
 Freely floating
 Exchange rate determined by the market’s
supply and demand for the currency.
Governments may occasionally intervene and
buy or sell their currency to stabilize
fluctuations.
 Managed floating
 Significant government intervention manages
the exchange rate by manipulating the
currency’s supply and demand. The target
exchange rates are kept secret to prevent
currency speculators from profiting from it.
Fixed Monetary Agreements
 No local currency
 The country uses either another country’s
currency as its legal tender (like the U.S. dollar in
Ecuador) or else belongs to a group of countries
that share a currency (like the euro).

Fixed Monetary Agreements
 Fixed peg arrangement

 The country “pegs” its currency to another (or a
basket of currencies) at a fixed rate. Slight
fluctuations are okay, but the rate must stay
within a desired range. For example, the
Chinese yuan is pegged to a basket of
currencies.

What is difference between spot rates
and forward rates?
 Spot rates are the rates to buy currency for
immediate delivery.
 Forward rates are the rates to buy currency
at some agreed-upon date in the future.

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.

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.
ft 1  rh

e0 1  rf
ft  t - period forward exchange rate
e0  today' s spot exchange rate
rh  periodic interest rate in home country
rf  periodic interest rate in foreign country
Evaluating Interest Rate Parity
 Suppose one yen buys $0.0095 in the 30-day

forward exchange market and rNOM for a 30-
day risk-free security in Japan and in the U.S.
is 4%.
ft  0.0095
rh  4%/12  0.333%
rf  4%/12  0.333%

Does interest rate parity hold?
0.0095 1.0033

e0 1.0033
0.0095
1
e0
e 0  0.0095
 For interest rate parity to hold, e0 must

equal $0.0095, but we were given earlier
that e0 = $0.0090, so interest rate parity
does not hold.
Which security offers the highest
return?
 The Japanese security.
 Convert $1,000 to yen in the spot market.
$1,000 x 111.111 = 111,111 yen.
 Invest 111,111 yen in 30-day Japanese security.
In
30 days receive 111,111 yen x 1.00333 = 111,481
yen.
 Agree today to exchange 111,481 yen 30 days from
now at forward rate, 111,481/105.2632 = $1,059.07.
 30-day return = $59.07/$1,000 = 5.907%, nominal
annual return = 12 x 5.907% = 70.88%.

What is purchasing power parity?
 Purchasing power parity implies that the level

of exchange rates adjusts so that identical
goods cost the same amount in different
countries.
Ph  Pf (e 0 )
 OR 
e 0  Ph /Pf

If grapefruit juice costs $2.00 per liter in the U.S.
and PPP holds, and USD/AUD = $0.65 what is the
price of grapefruit juice in Australia?
e0 = Ph/Pf
$0.6500 = $2.00/Pf
Pf = $2.00/$0.6500
Pf = 3.0769 Australian dollars

 Problem 19-11
PURCHASING POWER PARITY
In the spot market, 12.8 Mexican pesos can be exchanged for 1 U.S. dollar. A compact disc costs $10
in the United States. If purchasing power parity (PPP) holds, what should be the price of the same
disc in Mexico?

International Credit Markets
 Foreign bonds
 Issued in a capital market other than the
issuer’s.
 The only thing foreign about it is the borrower’s
nationality.

American Depository Receipts (ADRs)
 Certificates representing ownership of foreign

stock held in trust.
 About 1,700 ADRs are now available in the
United States, with most of them traded on
the over-the-counter (OTC) market.
 However, more and more ADRs are being
listed on the New York Stock Exchange.

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Chapter 19

 A corporation that operates

Dr. Saad Alnahedh - College of Business Administration - Kuwait University 2

Dr. Saad Alnahedh - College of Business Administration - Kuwait University 3

1. Different currency denominations.

Dr. Saad Alnahedh - College of Business Administration - Kuwait University 4

 Are these currency prices direct or indirect

Dr. Saad Alnahedh - College of Business Administration - Kuwait University 5

 The number of units of a foreign currency

Dr. Saad Alnahedh - College of Business Administration - Kuwait University 6

 Simply find the inverse of the direct

Dr. Saad Alnahedh - College of Business Administration - Kuwait University 7

 The exchange rate between any two currencies.

Dr. Saad Alnahedh - College of Business Administration - Kuwait University 9

A. dollar profit  6  3.45  2.55 A. dollars

U.S. dollar profit  2.55/1.5385  $1.66

Dr. Saad Alnahedh - College of Business Administration - Kuwait University

 The risk that the value of a cash flow in one

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 The framework within which exchange rates

Dr. Saad Alnahedh - College of Business Administration - Kuwait University

Dr. Saad Alnahedh - College of Business Administration - Kuwait University

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 Fixed peg arrangement

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Dr. Saad Alnahedh - College of Business Administration - Kuwait University 19

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 Interest rate parity holds that investors

 Suppose one yen buys $0.0095 in the 30-day

Dr. Saad Alnahedh - College of Business Administration - Kuwait University 22

 For interest rate parity to hold, e0 must

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 Purchasing power parity implies that the level

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Dr. Saad Alnahedh - College of Business Administration - Kuwait University

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 Certificates representing ownership of foreign

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