INTERNATIONAL CASH
MANAGEMENT
Flavio Bazzana
International Corporate Finance
LECTURE OBJECTIVES
• Explain the difference in analyzing cash
perspective versus a parent perspective
ows from a subsidiary
• Explain the various techniques used to optimize cash
• Explain common complications in optimizing cash
ows
ows
• Explain the potential bene ts and risks of foreign investments
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PERSPECTIVE
CASH FLOW ANALYSIS:
SUBSIDIARY PERSPECTIVE
• The management of working capital has a direct in uence on
the amount and timing of cash ow
• Subsidiary expenses
• it is dif cult to forecast the payments for international purchases of
raw materials or supplies because of exchange rate uctuations,
quotas, sales volume volatility, etc.
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CASH FLOW ANALYSIS:
SUBSIDIARY PERSPECTIVE
• Subsidiary revenue
• International sales may be more volatile than domestic sales
because of exchange rate uctuations, business cycles, etc.
• Subsidiary dividend payments
• if the payments and fees (royalties, overhead charges) for the
parent are known and denominated in the subsidiary’s currency,
forecasting cash ows will be easier
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CASH FLOW ANALYSIS:
SUBSIDIARY PERSPECTIVE
• Subsidiary liquidity management
• after accounting for all cash out ows and in ows, the subsidiary
must either invest its excess cash or borrow to cover its cash
de ciencies
• if the subsidiary has access to lines of credit and overdraft facilities,
it may maintain adequate liquidity without substantial cash balances
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CENTRALIZED CASH
MANAGEMENT
• While each subsidiary is managing its working capital, a
centralized cash management group is needed to monitor and
possibly manage the parent-subsidiary and inter subsidiary
cash ows
• International cash management can be segmented into two
functions
• optimizing cash
ow movements
• investing excess cash
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CENTRALIZED CASH
MANAGEMENT
• The centralized cash management division of an MNC cannot
always accurately forecast the events that affect parentsubsidiary or inter subsidiary cash ows
• It should, however, be ready to react to any event by
considering
• any potential adverse impact on cash
ows
• how to avoid such adverse impacts
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TECHNIQUES
TECHNIQUES TO OPTIMIZE
CASH FLOWS
• Accelerating cash in ows
• the more quickly the cash in ows are received, the more quickly
they can be invested or used for other purposes
• standard methods include the establishment of lockboxes around
the world (to reduce mail oat) and preauthorized payments
(charging a customer’s bank account directly)
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TECHNIQUES TO OPTIMIZE
CASH FLOWS
• Minimizing currency conversion costs
• netting reduces administrative and transaction costs through the
accounting of all transactions that occur over a period to determine
one net payment
• a bilateral netting system involves transactions between two units
• a multilateral netting system usually involves more complex
interchanges
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Payments owed by
subsidiary located in:
US dollar value owed to subsidiary located in:
Canada
France
Japan
Switzerland
US
Canada
-
40
90
20
40
France
60
-
30
60
50
Japan
100
30
-
20
30
Switzerland
10
50
10
-
50
US
10
60
20
20
-
Net payments to be
made by subsidiary
located in:
Net (bilateral) US dollar value owed to subsidiary located in:
Canada
France
Japan
Swiss
US
Canada
-
0
0
10
30
France
20
-
0
10
0
Japan
10
0
-
10
10
Switzerland
0
0
0
-
30
US
0
10
0
0
-
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Net payments to
be made by
subsidiary
located in:
Net (multilateral) US dollar value owed to subsidiary
located in:
Net
Total
payment
owed by:
by:
Canada
France
Japan
Swiss
US
Canada
-
0
0
10
30
40
10
France
20
-
0
10
0
30
20
Japan
10
0
-
10
10
30
30
Switzerland
0
0
0
-
30
30
0
US
0
10
0
0
-
10
0
Total owed to:
30
10
0
30
70
Net owed to:
0
0
0
0
60
60
60
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TECHNIQUES TO OPTIMIZE
CASH FLOWS
• Managing blocked funds
• a government may require that funds remain within the country to
create jobs and reduce unemployment
• an MNC can shift cost-incurring activities (like R&D) to the host
country, adjust the transfer pricing policy (such that higher fees must
be paid to the parent), borrow locally rather than from the parent,
etc.
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TECHNIQUES TO OPTIMIZE
CASH FLOWS
• Managing inter subsidiary cash transfers
• a subsidiary with excess funds can provide
nancing by paying for
its supplies earlier than is necessary
• this technique is called leading
• alternatively, a subsidiary in need of funds can be allowed to lag its
payments
• this technique is called lagging
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COMPLICATIONS
COMPLICATIONS
IN OPTIMIZING CASH FLOWS
• Company-related characteristics
• when a subsidiary delays its payments to the other subsidiaries, the
other subsidiaries may be forced to borrow until the payments
arrive
• Government restrictions
• some governments may prohibit the use of a netting system or
periodically prevent cash from leaving the country
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COMPLICATIONS
IN OPTIMIZING CASH FLOWS
• Characteristics of banking systems
• the abilities of banks to facilitate cash transfers for MNCs may vary
among countries
• the banking systems in different countries usually differ too
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INVESTING
INVESTING EXCESS CASH
• Excess funds can be invested in domestic or foreign short-
term securities, such as Eurocurrency deposits, Treasury bills,
and commercial papers
• Sometimes, foreign short-term securities have higher interest
rates
• however,
rms must also account for the possible exchange rate
movements
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S/T INTEREST RATES 2004
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INVESTING EXCESS CASH
• Centralized cash management
• centralized cash management allows for more ef cient usage of
funds and possibly higher returns
• when multiple currencies are involved, a separate pool may be
formed for each currency
• funds can also be invested in securities that are denominated in the
currencies needed in the future
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INVESTING EXCESS CASH
• Centralized cash management
• given the current online technology, MNCs should be able to
ef ciently create a multinational communications network among
their subsidiaries to ensure that information about their cash
positions is continually updated
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DETERMINING THE
EFFECTIVE YIELD
• The effective yield can be written as
rf = (1+ if )(1+ ef ) −1
• where if is the foreign investment rate
• ef is the % increase in the foreign currency’s spot rate
• And is approximately equal to if + ef
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INVESTING EXCESS CASH
• Implications of Interest Rate Parity (IRP)
• a foreign currency with a high interest rate will typically exhibit a
forward discount that re ects the differential between its interest
rate and the investor’s home interest rate
• however, short-term foreign investing on an uncovered basis may
still result in a higher effective yield
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INVESTING EXCESS CASH
• Use of the forward rate as a forecast
• if IRP exists, the forward rate can be used as a break-even point to
assess the short-term investment decision
• the effective yield will be higher than the domestic yield if the spot
rate at maturity is more than the forward rate at the time the
investment was undertaken
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Scenario
Implications for investing
IRP holds
Covered interest arbitrage is not worthwhile
IRP holds and the forward rate is an accurate forecast of Uncovered investment in a foreign security is not
the future spot rate
wothwhile
IRP holds and the forward rate is expected to
overestimate the future spot rate
Uncovered investment is expected to earn a lower
effective yield than an investment in a domestic security
IRP holds and the forward rate is expected to
underestimate the future spot rate
Uncovered investment is expected to earn an higher
effective yield than an investment in a domestic security
IRP does not hold and the forward premium (discount)
exceeds (is less than) the interest rate differential
Covered interest arbitrage is feasible for investor residing
in the home country
IRP does not hold and the forward premium (discount) is
Covered interest arbitrage is feasible for foreign investor
less than (exceeds) the interest rate differential
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INVESTING EXCESS CASH
• Use of exchange rate forecasts
• given an exchange rate forecast, the expected effective yield of a
foreign investment can be computed and then compared with the
local investment yield
• it may be helpful to use probability distributions instead of point
estimates or to compute the break-even exchange rate that will
equate foreign and local yields
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INVESTING EXCESS CASH
• Deriving the value of ef that equates foreign and domestic
yields
rf = (1+ if )(1+ ef ) −1
ef =
• where rf =11% and if =14%
1+ rf
1+ if
−1
• breakeven ef =-2,36%
• If the foreign currency depreciates by less than 2,63%, the
foreign currency deposit will be more rewarding
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Rate of change in the
Australian dollar
Probability
Effective yield
Expected value
-10%
5%
2,60%
0,13%
-8%
10%
4,88%
0,49%
-4%
15%
9,44%
1,42%
-2%
20%
11,72%
2,34%
1%
20%
15,14%
3,03%
2%
15%
16,28%
2,44%
3%
10%
17,42%
1,74%
4%
5%
18,56%
0,93%
Australian yield
14%
12,52%
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Probability distribution of effective yield
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Probability
15
10
5
0
2,60%
4,88%
9,44%
11,72%
15,14%
16,28%
17,42%
18,56%
Effective nancing rate
UK yield 11% probability 30%
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INVESTING EXCESS CASH
• Diversifying cash across currencies
• if an MNC is not sure of how exchange rates will change over time,
it may prefer to diversify its cash among securities that are
denominated in different currencies
• the degree to which such a portfolio will reduce risk depends on
the correlations among the currencies
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INVESTING EXCESS CASH
• Use of dynamic hedging to manage cash
• dynamic hedging refers to the strategy of hedging when the
currencies held are expected to depreciate and not hedging when
they are expected to appreciate
• the overall performance is dependent on the
rm’s ability to
accurately forecast the direction of exchange rate movements
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