Chapter 14
International Short-Term Financing
and Investment
Objectives
• To explain why short-term foreign currency financing
and investment are considered
• To consider the choice between domestic and
foreign currency financing and investment
• To identify the costs and benefits of
financing/investment with a portfolio
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PPTs t/a International Finance: An Analytical Approach 3e by Imad A. Moosa
Slides prepared by Afaf Moosa
14-2
Internal financing
• A multinational firm can utilise internal financing by:
requesting a transfer of funds from a subsidiary
increasing mark-ups on supplies sent to subsidiaries
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PPTs t/a International Finance: An Analytical Approach 3e by Imad A. Moosa
Slides prepared by Afaf Moosa
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Sources of external financing
• Standby Eurocredits: Eurocurrency lines and
revolving commitments
• Euronotes: note issuance facilities and Eurocommercial papers
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PPTs t/a International Finance: An Analytical Approach 3e by Imad A. Moosa
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Why foreign currency financing?
• Foreign currency financing introduces FX risk only if
there is no exposure already
• It may be cheaper
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PPTs t/a International Finance: An Analytical Approach 3e by Imad A. Moosa
Slides prepared by Afaf Moosa
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Three-month interest rates (Australia)
20
16
12
8
4
0
1984Q4
1987Q4
1990Q4
1993Q4
1996Q4
1999Q4
2002Q4
Copyright  2010 McGraw-Hill Australia Pty Ltd
PPTs t/a International Finance: An Analytical Approach 3e by Imad A. Moosa
Slides prepared by Afaf Moosa
2005Q4
2008Q4
14-6
Three-month interest rates (U.S.)
16
12
8
4
0
1984Q4
1987Q4
1990Q4
1993Q4
1996Q4
1999Q4
2002Q4
Copyright  2010 McGraw-Hill Australia Pty Ltd
PPTs t/a International Finance: An Analytical Approach 3e by Imad A. Moosa
Slides prepared by Afaf Moosa
2005Q4
2008Q4
14-7
Three-month interest rates (Japan)
10
8
6
4
2
0
1984Q4
1987Q4
1990Q4
1993Q4
1996Q4
1999Q4
2002Q4
Copyright  2010 McGraw-Hill Australia Pty Ltd
PPTs t/a International Finance: An Analytical Approach 3e by Imad A. Moosa
Slides prepared by Afaf Moosa
2005Q4
2008Q4
14-8
Three-month interest rates (U.K.)
16
12
8
4
0
1984Q4
1987Q4
1990Q4
1993Q4
1996Q4
1999Q4
2002Q4
Copyright  2010 McGraw-Hill Australia Pty Ltd
PPTs t/a International Finance: An Analytical Approach 3e by Imad A. Moosa
Slides prepared by Afaf Moosa
2005Q4
2008Q4
14-9
Effective financing rate from an Australian
perspective (USD)
24
16
8
0
-8
-16
1984Q4
1987Q4
1990Q4
1993Q4
1996Q4
1999Q4
2002Q4
Copyright  2010 McGraw-Hill Australia Pty Ltd
PPTs t/a International Finance: An Analytical Approach 3e by Imad A. Moosa
Slides prepared by Afaf Moosa
2005Q4
2008Q4
14-10
Effective financing rate from an Australian
perspective (JPY)
24
16
8
0
-8
-16
-24
1984Q4
1987Q4
1990Q4
1993Q4
1996Q4
1999Q4
2002Q4
Copyright  2010 McGraw-Hill Australia Pty Ltd
PPTs t/a International Finance: An Analytical Approach 3e by Imad A. Moosa
Slides prepared by Afaf Moosa
2005Q4
2008Q4
14-11
Effective financing rate from an Australian
perspective (GBP)
30
20
10
0
-10
-20
1984Q4
1987Q4
1990Q4
1993Q4
1996Q4
1999Q4
2002Q4
Copyright  2010 McGraw-Hill Australia Pty Ltd
PPTs t/a International Finance: An Analytical Approach 3e by Imad A. Moosa
Slides prepared by Afaf Moosa
2005Q4
2008Q4
14-12
International short-term investment
• International short-term investment is the placement
of excess funds in short-term investments
denominated in various currencies
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PPTs t/a International Finance: An Analytical Approach 3e by Imad A. Moosa
Slides prepared by Afaf Moosa
14-13
Short-term investment
• Time deposits
• Certificates of deposit:
Tap CDs
Tranche CDs
Rollover CDs
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The effective financing rate
e  (1  i )(1  S )  1
e  i  S
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PPTs t/a International Finance: An Analytical Approach 3e by Imad A. Moosa
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14-15
The effective rate of return
r  (1  i )(1  S )  1
r  i  S
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PPTs t/a International Finance: An Analytical Approach 3e by Imad A. Moosa
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The effect of changes in the exchange rate
• Foreign currency appreciation

e  i
• Foreign currency depreciation

e  i
• No change

e  i
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PPTs t/a International Finance: An Analytical Approach 3e by Imad A. Moosa
Slides prepared by Afaf Moosa
14-17
The effective financing rate with bid-offer
spread
e
  S a1 
(1  ia )  
 Sb 0 
1
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PPTs t/a International Finance: An Analytical Approach 3e by Imad A. Moosa
Slides prepared by Afaf Moosa
14-18
The effective rate of return with bid-offer
spread
r
  Sb1 
(1  ib )  
 Sa 0 
1
Copyright  2010 McGraw-Hill Australia Pty Ltd
PPTs t/a International Finance: An Analytical Approach 3e by Imad A. Moosa
Slides prepared by Afaf Moosa
14-19
Implications of CIP
• If covered interest parity (CIP) holds, the effective
financing rate and the rate of return will be equal to
the domestic interest rate
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PPTs t/a International Finance: An Analytical Approach 3e by Imad A. Moosa
Slides prepared by Afaf Moosa
14-20
Measuring risk: probability distributions
n
E (e)   ei pi
i 1
σ (e)   pi ei  E (e)
2
n
2
i 1
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PPTs t/a International Finance: An Analytical Approach 3e by Imad A. Moosa
Slides prepared by Afaf Moosa
14-21
Measuring risk: historical data
1n
e   et
n t 1
1 n
2
 et  e 
 (e) 
n  1 t 1
2
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PPTs t/a International Finance: An Analytical Approach 3e by Imad A. Moosa
Slides prepared by Afaf Moosa
14-22
Financing with and investment in a portfolio of
currencies
wy  wz  1
eip, j  wy eiy  wz e zj
n m
 
i 1 j 1
piy p zj  1
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PPTs t/a International Finance: An Analytical Approach 3e by Imad A. Moosa
Slides prepared by Afaf Moosa
14-23
Centralised versus decentralised cash
management
• Centralised: receipts and payments in various
currencies are managed by a central body
• Decentralised: receipts and payments are managed
by branches and subsidiaries
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PPTs t/a International Finance: An Analytical Approach 3e by Imad A. Moosa
Slides prepared by Afaf Moosa
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Advantages of centralised cash management
• Netting involves the calculation of the overall position
in each currency by adding up short and long
positions of branches and subsidiaries
• Netting provides a natural hedge when there is a
short position in one currency and an equivalent long
position in the same currency
(cont.)
Copyright  2010 McGraw-Hill Australia Pty Ltd
PPTs t/a International Finance: An Analytical Approach 3e by Imad A. Moosa
Slides prepared by Afaf Moosa
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Bilateral netting
500 000
Before
Netting
A
B
300 000
After
A
200 000
B
Netting
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PPTs t/a International Finance: An Analytical Approach 3e by Imad A. Moosa
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Multilateral netting
After Netting
Before Netting
A
B
D
C
B
A
B
D
C
(cont.)
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PPTs t/a International Finance: An Analytical Approach 3e by Imad A. Moosa
Slides prepared by Afaf Moosa
14-27
400 000
Multilateral
netting (cont.)
A
B
200 000
1600 000
B
300 000
C
B
D
C
C
500 000
400 000
C
600 000
D
900 000
1200 000
A
D
700 000
600 000
B
D
1200 000
300 000
A
100 000
C
A
C
900 000
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PPTs t/a International Finance: An Analytical Approach 3e by Imad A. Moosa
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Advantages of centralised cash management
(cont.)
• Currency diversification means that even if the
combined position is not zero, centralised cash
management may result in a combined position that
is so diversified that foreign exchange risk is reduced
significantly, removing the need to hedge individual
positions
(cont.)
Copyright  2010 McGraw-Hill Australia Pty Ltd
PPTs t/a International Finance: An Analytical Approach 3e by Imad A. Moosa
Slides prepared by Afaf Moosa
14-29
Advantages of centralised cash management
(cont.)
• Pooling: by pooling cash balances in a centralised
location, the cash requirements of any branch or
subsidiary anywhere can be met without having to
keep balances denominated in various currencies in
every locality
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PPTs t/a International Finance: An Analytical Approach 3e by Imad A. Moosa
Slides prepared by Afaf Moosa
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When is decentralised management preferred?
• When delays are expected in transferring funds to
countries with inefficient banking systems
• When local representation is necessary
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PPTs t/a International Finance: An Analytical Approach 3e by Imad A. Moosa
Slides prepared by Afaf Moosa
14-31
Factors determining where cash balances are
held
•
•
•
•
Whether or not funds are needed in the future
Whether or not there is a forward market
Political risk
Liquidity considerations
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PPTs t/a International Finance: An Analytical Approach 3e by Imad A. Moosa
Slides prepared by Afaf Moosa
14-32