IBUS 302:
International Finance
Topic 21-Cash Management
Lawrence Schrenk, Instructor
1 (of 30)
Learning Objectives
1.
2.
3.
Explain the importance of international cash
balances.▪
Describe exposure netting and other cash
management techniques.
Describe transfer pricing, arms length price,
and blocked funds.▪
2 (of 30)
The Management of
International Cash Balances

Decision Variables:



Size of Cash Balances
Currency of Cash Balances
Location of Cash Balances
Size of Cash Balances

The Liquidity Trade-Off



The cost of keeping “too much” cash on hand,
i.e. the opportunity costs of holding cash (lower
return).
The cost of not keeping enough cash on hand,
i.e. the trading costs associated with having too
little cash (transaction costs, short-term debt
costs, etc.)
The variability of cash flows.
Costs in dollars of holding cash
Size of Cash Balances
Trading costs increase when the
firm must sell securities to meet
cash needs.
Total cost of holding
cash
Opportunity
Costs
The investment income
foregone when holding
cash.
Trading
costs
C* ▪
Size of cash balance
▪
Currency of Cash Balances


By maintaining cash balances in a particular
currency, the MNC is essentially speculating
in that currency.
Strategies:


Pooling
Netting
Location of Cash Balances



Should the firm have centralized cash
management in the home country?
Or should the firm let each affiliate handle it
locally?
Where are borrowing costs lowest and
investment returns highest?
New Challenges





Cash Flow Complexity
Political Risk
Legal and Ethical Issues
Tax Issues
Foreign Exchange (FX) Exposure
8 (of 28)
Cash Management Techniques




Pooling
Netting
Multicurrency Accounts
Hedging
9 (of 28)
Pooling




Company and all its subsidiaries must maintain
accounts at the same bank
Notional pooling: Positive and negative balances
are aggregated each day to calculate interest
earned or due; funds are not actually transferred
but merely totaled
Some type of credit facilities are usually required
to support negative balances in the pool
Most pooling is currently single-currency/one
country
10 (of 28)
Exposure Netting

Bilateral Netting



Purchases between two subsidiaries are
periodically netted against each other.
Payments netted in different currencies are
converted to a common reference currency.
Multilateral Netting


.
Purchases between multiple subsidiaries are
periodically netted against each other.
Payments are combined ina common,
reference currency.
Exposure Netting
MNC has the following foreign exchange transactions:
$20
$30
$40
$10
$10
$35
$25
$60
$20
$30
Transactions: 12
Value: $350
$30
$40
Exposure Netting
MNC has the following foreign exchange transactions:
Disbursements
Receipts
US
Canada Germany
UK
US
—
30
35
60
Canada
20
—
10
40
Germany
10
25
—
30
UK
40
30
20
—
Total Dis.
Total R.
Net
Exposure Netting
Disbursements:
Disbursements
Receipts
US
Canada Germany
UK
US
—
30
35
60
Canada
20
—
10
40
Germany
10
25
—
30
UK
40
30
20
—
Total Dis.
70
85
65
130
Total R.
350
Net
Exposure Netting
Receipts:
Disbursements
Receipts
US
Canada Germany
UK
Total R.
US
—
30
35
60
125
Canada
20
—
10
40
70
Germany
10
25
—
30
65
UK
40
30
20
—
90
Total Dis.
70
85
65
130
350
Net
Exposure Netting
Net Cash Flows: ▪
Disbursements
Receipts
US
Canada Germany
UK
Total R.
Net
–
35
60
125
55▪
10
40
70
US
—
30
Canada
20
—
Germany
10
25
—
30
65
UK
40
30
20
—
90
Total Dis.
70
85
65
130
=
350
Exposure Netting
Net Cash Flows : ▪
Disbursements
Receipts
US
Canada Germany
UK
Total R.
Net
US
—
30
35
60
125
55
Canada
20
—
10
40
70
(15)
Germany
10
25
—
30
65
0
UK
40
30
20
—
90
(40)
Total Dis.
70
85
65
130
350
0
Exposure Netting
Complete Table :
Disbursements
Receipts
US
Canada Germany
UK
Total R.
Net
US
—
30
35
60
125
55
Canada
20
—
10
40
70
(15)
Germany
10
25
—
30
65
0
UK
40
30
20
—
90
(40)
Total Dis.
70
85
65
130
350
0
Exposure Netting

NOTES
1. Total disbursements must equal total
receipts.
70 + 85 + 65 + 130
= 125 + 70 + 65 + 90 = 350
2. Total net must equal zero.
55 – 15 – 40 = 0
19 (of 28)
Bilateral Netting
Bilateral Netting reduces transactions by half:
$20
$10
$30
$40
$20
$15
$10$25$35
$25
$60
$20
$10
$30
Transactions: 6
Value: $90
$10
$30$10$40
Bilateral Netting
Transactions:
Disbursements
Receipts
US
Canada Germany
UK
US
—
10
25
20
Canada
0
—
0
10
Germany
0
15
—
10
UK
0
0
0
—
Total Dis.
Total R.
Net
Bilateral Netting
Disbursements:
Disbursements
Receipts
US
Canada Germany
UK
US
—
10
25
20
Canada
0
—
0
10
Germany
0
15
—
10
UK
0
0
0
—
Total Dis.
0
25
25
40
Total R.
90
Net
Bilateral Netting
Receipts:
Disbursements
Receipts
US
Canada Germany
UK
Total R.
US
—
10
25
20
55
Canada
0
—
0
10
10
Germany
0
15
—
10
25
UK
0
0
0
—
0
Total Dis.
0
25
25
40
90
Net
Bilateral Netting
Net Cash Flows:
Disbursements
Receipts
US
Canada Germany
UK
Total R.
Net
US
—
10
25
20
55
55
Canada
0
—
0
10
10
(15)
Germany
0
15
—
10
25
0
UK
0
0
0
—
0
(40)
Total Dis.
0
25
25
40
90
0
Exposure Netting

NOTES
1. Total disbursements must equal total
receipts.
25 + 25 + 40
= 55 + 10 + 25 = 90
2. Total net must equal zero.
55 – 15 – 40 = 0
25 (of 28)
Key Idea

Expose netting never changes…

Net Cash Flows
Expose netting does change
disbursements and receipts.
 Expose netting decreases transactions
and total value of cash flows.

26 (of 28)
Multilateral Netting

Two Suggestions:
Use the one set of values you know…



Net cash flows to each unit.
Start the calculations with the subsidiaries and
end with the parent.
27 (of 28)
Multilateral Netting
Net Cash Flows:
Disbursements
Receipts
US
Canada
Germany
UK
Total Dis.
US
Canada Germany
UK
—
Total R.
Net
55
—
(15)
—
0
—
(40)
0
Multilateral Netting
Canada pays its net cash flow to parent:
Disbursements
Receipts
US
Canada
Germany
UK
Total Dis.
US
—
Canada Germany
UK
Total R.
Net
15
55
—
(15)
—
0
—
(40)
0
Multilateral Netting
England pays its net cash flow to parent:
Disbursements
Receipts
US
Canada
Germany
UK
Total Dis.
US
—
Canada Germany
15
UK
40
—
Total R.
Net
55
(15)
—
0
—
(40)
0
Multilateral Netting
Germany pays its net cash flow to parent:
Disbursements
Receipts
US
Canada
Germany
UK
Total Dis.
US
—
Canada Germany
15
0
UK
40
—
Total R.
Net
55
(15)
—
0
—
(40)
0
Multilateral Netting
All other transactions are zero:
Disbursements
Receipts
US
Canada Germany
UK
Total R.
Net
US
—
15
0
40
55
Canada
0
—
0
0
(15)
Germany
0
0
—
0
0
UK
0
0
0
—
(40)
Total Dis.
0
Multilateral Netting
Disbursements:
Disbursements
Receipts
US
Canada Germany
UK
Total R.
Net
US
—
15
0
40
55
Canada
0
—
0
0
(15)
Germany
0
0
—
0
0
UK
0
0
0
—
(40)
Total Dis.
0
15
0
40
0
Multilateral Netting
Receipts:
Disbursements
Receipts
US
Canada Germany
UK
Total R.
Net
US
—
15
0
40
55
55
Canada
0
—
0
0
0
(15)
Germany
0
0
—
0
0
0
UK
0
0
0
—
0
(40)
Total Dis.
0
15
0
40
55
0
Multilateral Netting
Multilateral netting is even more effective:
$10
$30
$40
$20
$40
$15
$15
$15$25
$15
$10
$10
$10
$10
Transactions: 2
Value: $55
Multilateral Netting with
Central Depository
Some firms use a central depository as a cash pool to
facilitate funds mobilization and reduce the chance
of misallocated funds.
$15
$55
Central
depository
$40
Multilateral Netting with
Central Depository
Consider the net cash flows of the affiliates with
the rest of the world:
Affiliate
U.S.
Canada
Germany
U.K.
Total
Net Receipts
Net Excess Cash
from Multilateral from Transactions
Netting
with Third Parties
Net Flow
$55,000
$20,000
$35,000
($15,000)
($30,000)
$15,000
0
$75,000
($75,000)
($40,000)
($25,000)
($15,000)
($40,000)
Multilateral Netting with
Central Depository
Net cash flows after multilateral netting and net
payments from external transactions
$35
$15
Central
depository
$75
$15
Netting and FX


The examples have used dollars.
Where do other currencies fit in?
39 (of 28)
Transfer Pricing


The Transfer Price is the price that for
accounting purposes, is assigned to goods
and services flowing from one division of a
firm to another division.
Controversial even for a domestic firm.


Consider the example of a firm that has one
division that mills lumber and another that makes
furniture.
The transfer price of the lumber is a political as
well as economic and accounting issue.
International Transfer Pricing

Added complications :



Differences in tax rates
Exchange rate restrictions on the part of the host
country.
Most countries have regulations controlling
transfer pricing.

In the U.S., the tax code requires transfer prices to
be arms length prices.
Arms Length Price


A price that a willing seller would charge a
willing unrelated buyer.
The IRS prescribes three methods for
estimating an arms length price



Comparable uncontrolled price.
Resale price: the price at which the good is resold
by the affiliate is reduced by overhead and profit.
Cost-plus approach: an appropriate profit is
added to the cost of the manufacturing affiliate.
Blocked Funds
Restrictions on the movement of funds
in a specific currency.
 A form of political risk is the risk that
the foreign government may impose
exchange restrictions on its own
currency.

Blocked Funds Strategies

Additional strategies for unblocking funds:



Direct negotiation
Export creation
Using the blocked funds to buy goods and
services for the MNC.



Transfer local expatriates from home payroll to the
local subsidiaries payroll.
Transfer pricing
Swaps