Lecture Objectives
• Explain working capital management from a subsidiary perspective versus a
parent perspective.
• Explain how cash management can be centralized in order to ensure that
cash is used more efficiently.
• Explain the various techniques used to optimize cash flows.
• Explain the decision to invest cash internationally.
Lecture 14
International Cash Management
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2
Multinational Working Capital Management (1 of 2)
Subsidiary Expenses
• The subsidiary will normally have a more difficult time forecasting future
outflow payments if its purchases are international rather than domestic
because of exchange rate fluctuations.
Cash management is the optimization of cash flows and the
investment of excess cash.
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Subsidiary Revenue
• Subsidiaries’ sales volume may be more volatile than if the goods were only
sold domestically. Accounts receivable management is an important part of
the subsidiary’s working capital management because of its potential impact
on cash inflows.
3
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4
Multinational Working Capital Management (2 of 2)
Centralized Cash Management (1 of 2)
Subsidiary Dividend Payments
• When dividend payments and fees are known in advance and denominated
in the subsidiary's currency, forecasting cash flows is easier.
Decentralized management is not optimal because it will force MNC to
maintain larger cash investment than necessary.
Subsidiary Liquidity Management
• After accounting for all outflow and inflow payments, the subsidiary may have
excess or deficient cash. It uses liquidity management to invest excess cash
or borrow to cover cash deficiencies.
See Exhibit 2.1 on next slide.
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MNCs commonly use centralized cash management to monitor and manage
the parent-subsidiary and intersubsidiary cash flows.
5
Exhibit 21.1 Cash Flow of the Overall MNC
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6
Centralized Cash Management (2 of 2)
Accommodating Cash Shortages: A key role of the centralized cash
management division is to facilitate the transfer of funds from subsidiaries with
excess funds to those that need funds.
• Technology Used to Facilitate Fund Transfers
o A centralized cash management system needs continual flow of information
about currency positions to determine whether one subsidiary’s shortage of cash
can be covered by another subsidiary’s excess cash.
• Monitoring of Cash Positions
o The centralized cash management division serves as a monitor over the
subsidiaries because it can detect potential financial problems.
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8
Optimizing Cash Flows (1 of 2)
Exhibit 21.2 Intersubsidiary Payments Matrix
U.S. DOLLAR
VALUE (IN
THOUSANDS)
OWED TO
SUBSIDIAIRY
LOCATED IN
JAPAN
U.S. DOLLAR
VALUE (IN
THOUSANDS)
OWED TO
SUBSIDIAIRY
LOCATED IN
SWITZERLAND
U.S. DOLLAR
VALUE (IN
THOUSANDS)
OWED TO
SUBSIDIAIRY
LOCATED IN
UNITED
STATES
40
90
20
40
—
30
60
50
100
30
—
20
30
Switzerland
10
50
10
—
50
United States
10
60
20
20
—
Accelerating Cash Inflows using lockboxes and preauthorized payments.
Minimizing currency conversion costs by netting, using a bilateral netting
system or a multilateral netting system. (Exhibits 21.2 and 21.3)
Managing intersubsidiary cash transfers by using a leading or lagging
strategy.
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Exhibit 21.3 Netting Schedule
NET PAYMENTS TO BE MADE
BY SUBSIDIARY LOCATED IN
Canada
NET U.S.
DOLLAR
VALUE (IN
THOUSANDS)
OWED TO
SUBSIDIAIRY
LOCATED IN
FRANCE
NET U.S.
DOLLAR
VALUE (IN
THOUSANDS
) OWED TO
SUBSIDIAIRY
LOCATED IN
JAPAN
NET U.S.
DOLLAR
VALUE (IN
THOUSANDS)
OWED TO
SUBSIDIAIRY
LOCATED IN
SWITZERLAND
NET U.S.
DOLLAR VALUE
(IN THOUSANDS)
OWED TO
SUBSIDIAIRY
LOCATED IN
UNITED STATES
TOTAL
0
10
30
40
France
20
—
0
10
0
30
Japan
10
0
—
10
10
30
0
0
0
—
30
30
0
10
0
0
—
10
30
10
0
30
70
Total
—
France
60
Japan
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10
Complications in Optimizing Cash Flow
0
United States
Canada
Optimizing Cash Flows (2 of 2)
—
Switzerland
U.S. DOLLAR
VALUE (IN
THOUSANDS)
OWED TO
SUBSIDIAIRY
LOCATED IN
FRANCE
PAYMENTS OWED BY
SUBSIDIARY LOCATED
IN
Managing blocked funds by incurring costs within the country or using
transfer pricing.
NET U.S.
DOLLAR
VALUE (IN
THOUSANDS)
OWED TO
SUBSIDIAIRY
LOCATED IN
CANADA
U.S. DOLLAR
VALUE (IN
THOUSANDS)
OWED TO
SUBSIDIAIRY
LOCATED IN
CANADA
• Company related characteristics
o If one of the subsidiaries delays payments to other subsidiaries, the other
subsidiaries may be forced to borrow. A centralized approach that monitors all
intersubsidiary payments should minimize such problems.
• Government restrictions
o The existence of government restrictions can disrupt a cash flow optimization
policy.
• Limitations of Banking Systems
o The abilities of banks to facilitate cash transfers for MNCs vary among countries.
14th
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Edition. © 2021 Cengage. All Rights Reserved. May not be scanned,
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Investing Excess Cash (1 of 8)
Investing Excess Cash (2 of 8)
Determining the Effective Yield — The effective yield of a bank deposit
considers both the interest rate and the rate of appreciation (or depreciation) of
the currency denominating the deposit and can therefore be very different from
the quoted interest rate on a deposit denominated in a foreign currency.
Benefits of Investing in a Foreign Currency:
• An MNC’s excess funds can be invested in domestic or foreign short-term
securities. In some periods, the foreign short-term securities will have higher
interest rates than domestic interest rates and may therefore deserve
consideration by MNCs that have excess short-term funds available.
where r = effective yield on foreign deposit
if = quoted interest rate
ef = percentage change in value of currency
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Investing Excess Cash (3 of 8)
14
Investing Excess Cash (4 of 8)
Risk of Investing in a Foreign Currency:
• While an MNC might earn a higher effective yield from investing in a deposit
denominated in a foreign currency, its investment is subject to risk, or
uncertainty surrounding the effective yield.
Break-Even Point from Investing in a Foreign Currency:
• The forward rate can be viewed as a break-even point: If it represents an
accurate forecast of the future spot rate (which will exist at the end of the
deposit period), the effective yield on the foreign deposit will be equal to the
yield from investing domestically.
Hedging the Investment in a Foreign Currency
• MNCs that want to invest their cash in deposits with a high foreign interest
rate may consider hedging their investment in an attempt to avoid exposure
to exchange rate risk.
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o Relationship with the International Fisher Effect — The international Fisher effect
suggests that the exchange rate of a foreign currency is expected to change by
an amount reflecting the difference between its interest rate and the U.S. interest
rate. The rationale behind this theory is that a high nominal interest rate reflects
an expectation of high inflation, which could weaken the currency (according to
purchasing power parity).
15
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16
Investing Excess Cash (5 of 8)
Exhibit 21.4 Considerations When Investing Excess
Cash
Break-Even Point from Investing in a Foreign Currency (continued)
• Conclusions about the Forward Rate — Exhibit 21.4 summarizes the key
implications of interest rate parity and the forward rate as a predictor of future
spot rates for foreign investing.
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copied or duplicated, or posted to a publicly accessible website, in whole or in part.
17
Investing Excess Cash (6 of 8)
SCENARIO
IMPLICATIONS FOR INVESTING IN FOREIGN DEPOSITS
1. Interest rate parity exists.
Covered interest arbitrage is not worthwhile.
2. Interest rate parity exists, and the forward rate is an accurate
forecast of the future spot rate.
An uncovered investment in a foreign deposit is not worthwhile.
3. Interest rate parity exists, and the forward rate is an
unbiased forecast of the future spot rate.
An uncovered investment in a foreign deposit will on average
earn an effective yield similar to an investment in a domestic
deposit.
4. Interest rate parity exists, and the forward rate is expected to
overestimate the future spot rate.
An uncovered investment in a foreign deposit is expected to
earn a lower effective yield than an investment in a domestic
deposit.
5. Interest rate parity exists, and the forward rate is expected to
underestimate the future spot rate.
An uncovered investment in a foreign deposit is expected to
earn a higher effective yield than an investment in a domestic
deposit.
6. Interest fate parity does not exist, and the forward premium
(discount) exceeds (is less than) the interest rate differential.
Covered interest arbitrage is feasible for investors residing in the
home country.
7. Interest rate parity does not exist, and the forward premium
(discount) is less than (exceeds) the interest rate differential.
Covered interest arbitrage is feasible for foreign investors but not
for investors residing in the home country.
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18
Investing Excess Cash (7 of 8)
• Using a Probability Distribution to Enhance the Investment Decision
(Exhibits 21.5, 21.6, 21.7)
Investing in a Portfolio of Currencies
• Because an MNC cannot be sure how exchange rates will change over time,
it may prefer to diversify its cash among deposits denominated in different
currencies. Limiting the percentage of excess cash invested in each foreign
currency will reduce the MNC’s exposure to exchange rate risk.
Since even expert forecasts are not always accurate, it is sometimes useful
to develop a probability distribution instead of relying on a single prediction.
• Investing in a Portfolio of Currencies
Because an MNC cannot be sure how exchange rates will change over time,
it may prefer to diversify its cash among deposits denominated in different
currencies. Limiting the percentage of excess cash invested in each foreign
currency will reduce the MNC’s exposure to exchange rate risk.
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Exhibit 21.5 Analysis of Investing in a Foreign
Currency
Exhibit 21.6 Development of Possible Effective Yields
PROBABILITY OF
THAT
PERCENTAGE
CHANGE IN THE
SPOT RATE
OCCURRING
POSSIBLE RATE OF CHANGE
IN THE AUSTRALIAN DOLLAR
OVER THE LIFE OF THE
INVESTMENT (ef)
PROBABILITY OF
OCCURRENCE
+4%
70%
(1.07)[1 + (.04)] − 1 = .1128, or 11.28%
CURRENCY
POSSIBLE
PERCENTAGE
CHANGE IN THE
SPOT RATE OVER
THE DEPOSIT LIFE
−5%
30%
(1.07)[1 + (−.05)] − 1 = .0165, or 1.65%
Australian dollar
+4%
70%
(1.07)[1 + (.04)] − 1 = 11.28%
Australian dollar
−5%
30
(1.07)[1 + (−.05)] − 1 = 1.65%
Mexican peso
+2%
60%
Mexican peso
−4%
40%
EFFECTIVE YIELD IF THIS RATE OF
CHANGE IN THE AUSTRALIAN
DOLLAR OCCURS
100%
COMPUTATION OF EFFECTIVE
YIELD BASED ON THAT
PERCENTAGE CHANGE IN THE
SPOT RATE
100%
100%
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Exhibit 21.7 Analysis of Investing in Two Foreign
Currencies
MEXICAN
PESO
COMPUTATION OF
JOINT
PROBABILITY
COMPUTATION OF EFFECTIVE YIELD OF
PORTFOLIO (50% OF TOTAL FUNDS
INVESTED IN EACH CURRENCY)
11.28%
8.12%
(70%)(60%) = 42%
.5(11.28%) + .5(8.12%) = 9.70%
11.28%
1.76%
(70%)(40%) = 28%
.5(11.28%) + .5(1.76%) = 6.52%
1.65%
8.12%
(30%)(60%) = 18%
.5(1.65%) + .5(8.12%) = 4.885%
1.65%
1.76%
(30%)(40%) = 12%
.5(1.65%) + .5(1.76%) = 1.705%
(1.06)[1 + (−.04)] −1 = .0176 or 1.76%
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22
Investing Excess Cash (8 of 8)
Dynamic hedging: Strategy of applying a hedge when the currencies held are
expected to depreciate and removing the hedge when the currencies held are
expected to appreciate.
Possible Joint Effective Yield
AUSTRALIAN
DOLLAR
(1.06)[1 + (.02)] − 1 = .0812 or 8.12%
100%
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Summary (1 of 2)
Summary (2 of 2)
• MNCs strive to effectively manage their working capital, which includes
short-term assets such as inventory, accounts receivable, and cash.
Multinational management of working capital is complex for MNCs that
have foreign subsidiaries, because each subsidiary must have adequate
working capital to support its operations. The MNC may use a centralized
perspective to monitor cash positions and to ensure that funds can be
transferred among subsidiaries to accommodate cash deficiencies.
• An MNC’s centralized cash management can monitor cash flows between
subsidiaries and between each subsidiary and the parent. It can facilitate
the transfer of funds from subsidiaries with excess funds to those that need
funds so that the MNC uses its funds efficiently.
Jeff Madura, International Financial Management, 14th Edition. © 2021 Cengage. All Rights Reserved. May not be scanned,
copied or duplicated, or posted to a publicly accessible website, in whole or in part.
• Techniques to optimize cash flows include (1) accelerating cash inflows, (2)
minimizing currency conversion costs, (3) managing blocked funds, and (4)
implementing intersubsidiary cash transfers. MNCs may potentially achieve
higher returns by investing excess cash in foreign currencies that either have
relatively high interest rates or may appreciate over the investment period. If
the foreign currency depreciates over the investment period, however, this
may offset any interest rate advantage of that currency
25
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copied or duplicated, or posted to a publicly accessible website, in whole or in part.
26