Chapter 19

Multinational Financial Management

Learning Objectives

After reading this chapter, students should be able to:

Define the term multinational corporation and identify 7 primary reasons why firms go international.

List 5 major factors that distinguish financial management in firms operating entirely within a single country
from those that operate in several different countries.

Briefly explain the following terms: international monetary system, exchange rate, spot exchange rate,
forward exchange rate, fixed exchange rate, floating exchange rate, devaluation/revaluation of a currency,
depreciation/appreciation of a currency, soft currency, and hard currency.

Identify the different types of exchange rate systems.

Distinguish between direct and indirect quotations, and American and European term quotations, and
calculate cross rates between any two currencies.

Differentiate between spot and forward rates, and explain what it means for a forward currency to sell at a
discount or premium.

Briefly explain the concept of interest rate parity and write the corresponding equation.

Briefly explain the concept of purchasing power parity and write the corresponding equation.

Explain the implications of relative inflation rates, or rates of inflation in foreign countries compared with that
in the home country, on interest rates, exchange rates, and on multinational financial decisions.

Distinguish between foreign portfolio investments and direct investments, and briefly explain the following
terms: Eurocredits, Eurodollar, Eurobonds, and foreign bonds.

Explain why new issues of stock are sold in international markets.

Identify some key differences in capital budgeting as applied to foreign versus domestic operations including
the following terms: repatriation of earnings, exchange rate risk, political risk, country risk, and business
climate.

Explain whether international differences in capital structure exist.

List some factors that make working capital management especially complicated in a multinational
corporation.

Chapter 19: Multinational Financial Management Learning Objectives 493

 Lecture Suggestions

This chapter presents an overview of multinational financial management, including exchange rates, interest
rate and purchasing power parity, international capital markets, multinational capital budgeting,
international capital structures, and multinational working capital management.
What we cover, and the way we cover it, can be seen by scanning the slides and Integrated Case
solution for Chapter 19, which appears at the end of this chapter solution. For other suggestions about the
lecture, please see the Lecture Suggestions in Chapter 2, where we describe how we conduct our classes.

DAYS ON CHAPTER: 3 OF 58 DAYS (50-minute periods)

494 Lecture Suggestions Chapter 19: Multinational Financial Management

 Answers to End-of-Chapter Questions

19-1 Taking into account differential labor costs abroad, transportation, tax advantages, and so forth,
U.S. corporations can maximize long-run profits. There are also nonprofit behavioral and strategic
considerations, such as maximizing market share and enhancing the prestige of corporate officers.

19-2 A dollar will buy more euros.

19-3 There will be an excess supply of dollars in the foreign exchange markets, and thus, this will tend
to drive down the value of the dollar. Foreign investments in the United States will increase.

19-4 The foreign projects cash flows have to be converted to U.S. dollars, since the shareholders of the
U.S. corporation (assuming they are mainly U.S. residents) are interested in dollar returns. This
subjects them to exchange rate risk, and therefore requires an additional risk premium. There is
also a risk premium for political risk (mainly the risk of expropriation) that should be included.

19-5 No, interest rate parity implies that an investment in the U.S. with the same risk as a similar
investment in a foreign country should have the same return. Interest rate parity is expressed as
follows:
Forward exchange rate 1 rh
.
Spot exchange rate 1 rf

Interest rate parity shows why a particular currency might be at a forward premium or discount. A
currency is at a forward premium whenever domestic interest rates are higher than foreign interest
rates. Discounts prevail if domestic interest rates are lower than foreign interest rates. If these
conditions do not hold, then arbitrage will soon force interest rates back to parity.

19-6 Purchasing power parity assumes there are neither transactions costs nor regulations that limit the
ability to buy and sell goods across different countries. In many cases, these assumptions are
incorrect, which explains why PPP is often violated. An additional complication, when empirically
testing to see whether PPP holds, is that products in different countries are rarely identical.
Frequently, there are real or perceived differences in quality, which can lead to price differences in
different countries.

19-7 A Eurodollar is a dollar deposit in a foreign bank, normally a European bank. The foreign bank
need not be owned by foreignersit only has to be located in a foreign country. For example, a
Citibank subsidiary in Paris accepts Eurodollar deposits. The Frenchmans deposit at Chase
Manhattan Bank in New York is not a Eurodollar deposit. However, if he transfers his deposit to a
bank in London or Paris, it would be.
The existence of the Eurodollar market makes the Federal Reserves job of controlling U.S.
interest rates more difficult. Eurodollars are outside the direct control of the U.S. monetary
authorities. Because of this, interest rates in the U.S. cannot be insulated from those in other parts
of the world. Thus, any domestic policies the Federal Reserve might take toward interest rates
would be affected by the Eurodollar market.

Chapter 19: Multinational Financial Management Integrated Case 495

 Solutions to End-of-Chapter Problems

19-1 Dollars should sell for 1/1.50, or 0.6667 pound per dollar.

19-2 $1 = 4.0828 Israeli shekels; $1 = 111.23 Japanese yen; Cross-exchange rate, yen/shekel = ?

Dollars Yen Yen

Cross Rate: .
Shekel Dollar Shekel

Note that an indirect quotation is given for Israeli shekel; however, the cross rate formula requires
a direct quotation. The indirect quotation is the reciprocal of the direct quotation. Since $1 =
4.0828 shekels, then 1 shekel = $0.244930.

Yen/Shekel = $0.244930 per shekel 111.23 yen per dollar

= 27.2436 yen per shekel.

19-3 rNOM, 6-month T-bills = 7%; rNOM of similar default-free 6-month Japanese bonds = 5.5%; Spot
exchange rate: 1 yen = $0.009; 6-month forward exchange rate = ?

Forward exchange rate 1 rh

.
Spot exchange rate 1 rf

rf = 5.5%/2 = 2.75%.

rh = 7%/2 = 3.5%.

Spot exchange rate = $0.009.

Forward exchange rate 1.035

=
$0.009 1.0275
1.0275 Forward exchange rate = $0.00932
Forward exchange rate = $0.00907.

The 6-month forward exchange rate is 1 yen = $0.00907.

19-4 U.S. T.V. = $500; EMU T.V. = 725 euros; Spot rate between euro and dollar = ?

Ph = Pf(Spot rate)
$500 = 725 euros(Spot rate)
500/725 = Spot rate
$0.68966 = Spot rate.

1 euro = $0.68966 or $1 = 1.45 euros.

496 Integrated Case Chapter 19: Multinational Financial Management

19-5 From Table 19-1:
U.S. Dollars
Required to
Buy One Unit of Purchase Price
Currency Foreign Currency 1,000 = in Dollars
British pound 1.7471 1,000 = $1,747.10
Canadian dollar 0.8206 1,000 = 820.60
EMU euro 1.2069 1,000 = 1,206.90
Japanese yen 0.008974 1,000 = 8.97
Mexican peso 0.0931 1,000 = 93.10
Swedish krona 0.1281 1,000 = 128.10

19-6 a. Again the answer to this problem depends on the date it is assigned. If the exchange rates
taken from the November 16, 2005 issue of The Wall Street Journal are used; then the
following information is obtained:
U.S. Dollars
Required to
Buy One Unit of Purchase Price
Currency Foreign Currency 1,000 = in Dollars
British pound 1.7360 1,000 = $1,736.00
Canadian dollar 0.8388 1,000 = 838.80
EMU euro 1.1727 1,000 = 1,172.70
Japanese yen 0.008415 1,000 = 8.42
Mexican peso 0.0939 1,000 = 93.90
Swedish krona 0.1218 1,000 = 121.80

b. Pound = ($1,736.00 $1,747.10)/$1,747.10 = -0.00635 = -0.635%.

Canadian dollar = ($838.80 $820.60)/$820.60 = +0.02218 = +2.218%.

Euro = ($1,172.70 $1,206.90)/$1,206.90 = -0.02834 = -2.834%.

Yen = ($8.42 $8.97)/$8.97 = -0.06132 = -6.132%.

Peso = ($93.90 $93.10)/$93.10 = +0.00859 = +0.859%.

Krona = ($121.80 $128.10)/$128.10 = -0.04918 = -4.918%.

19-7 The price of krones is $0.14 today. A 10% appreciation will make it worth $0.154 tomorrow. A
dollar will buy 1/0.154 = 6.49351 krones tomorrow.

19-8 Cross rate = kronas/dollar dollars/pound = kronas/pound

= 10 1.5 = 15 kronas per pound.

Chapter 19: Multinational Financial Management Integrated Case 497

19-9 The answer to this question would depend upon the rates existing at the time the assignment is
made. Using the rates quoted in the Foreign Exchange table of the November 16, 2005, issue of
The Wall Street Journal:

U.S. $ Equivalent Currency per U.S. $

British pound 1.7360 0.5760
Swedish krona 0.1218 8.2102

Cross rate = kronas/dollar dollars/pound = kronas/pound

= 8.2102 1.7360 = 14.2529 kronas per pound.

19-10 Spot rate: 1 yen = $0.0086; Forward rate: 1 yen = $0.0086; rNOM of 90-day Japanese risk-free
securities = 4.6%; rNOM of 90-day U.S. risk-free securities = ?

rf = 4.6%/4 = 1.15%; rh = ?

Forward exchange rate 1 rh

=
Spot exchange rate 1 rf
$0.0086 1 rh
=
$0.0086 1.0115
1 rh
1 =
1.0115
1 + rh = 1.0115
rh = 0.0115.

rNOM = 1.15% 4 = 4.6%.

19-11 $1 = 7.8 pesos; CD = $15.00; Price of CD in Mexico = ?

1 Peso = 1/7.8 = $0.1282.

Ph = Pf(Spot rate)
$15 = Pf($0.1282)
$15
= 117 pesos.
$0.1282

Check: Spot rate = $15/117 pesos = $0.1282 for 1 peso.

19-12 a. rNOM of 90-day U.S. risk-free securities = 5%; rNOM of 90-day British risk-free securities = 5.3%;
Spot rate: 1 pound = $1.65; forward rate selling at premium or discount = ?

Forward exchange rate 1 rh

= .
Spot exchange rate 1 rf

rh = 5%/4 = 1.25%; rf = 5.3%/4 = 1.325%; Spot rate = $1.65.

498 Integrated Case Chapter 19: Multinational Financial Management

 Forward exchange rate 1.0125
=
$1.65 1.01325
Forward exchange rate
= 0.9993
$1.65
Forward exchange rate = $1.6488.

The forward rate is selling at a discount, since a pound buys fewer dollars in the forward
market than it does in the spot. In other words, in the spot market $1 would buy 0.6061
British pounds, but at the forward rate $1 would buy 0.6065 British pounds; therefore, the
forward currency is said to be selling at a discount.

b. The 90-day forward rate is $1.6488.

19-13 a. C$4,000,000/C$1.4430 = $2,772,002.77 $2,772,003, or

C$4,000,000 $0.6930 = $2,772,000. (Difference is due to rounding.)

b. C$4,000,000/C$1.4401 = $2,777,585, or

C$4,000,000 0.6944 = $2,777,600.

c. If the exchange rate is C$1.20 to $1 when payment is due in 3 months, the C$4,000,000 will
cost:
C$4,000,000/C$1.20 = $3,333,333,

which is $561,330 more than the spot price today and $555,748 more than purchasing a
forward contract for 90 days.

19-14 The U.S. dollar liability of the corporation falls from $0.75(5,000,000) = $3,750,000 to
$0.70(5,000,000) = $3,500,000, corresponding to a gain of 250,000 U.S. dollars for the
corporation. However, the real economic situation might be somewhat different. For example, the
loan is presumably a long-term loan. The exchange rate will surely change again before the loan is
paid. What really matters, in an economic sense, is the expected present value of future interest
and principal payments denominated in U.S. dollars. There are also possible gains and losses on
inventory and other assets of the firm. A discussion of these issues quickly takes us outside the
scope of this introductory textbook.

19-15 a. The automobiles value has increased because the dollar has declined in value relative to the yen.

b. 245/111 = 2.2072, so $9,000 2. 2072 = $19,864.86 $19,865.

Note that this represents a 3.7% compound annual increase over 22 years.

19-16 D1 = 3 pounds; Exchange rate = $1.60/pound; Pound depreciates 5% against $1. Dividend grows
at 10% and rs = 15%. 10 million shares outstanding.

Chapter 19: Multinational Financial Management Integrated Case 499

 1.10
g= 1 = 4.7619%.
1.05

D1
P0 =
rs g
3 $1.60
=
(0.15 0.047619)
$4.80
=
0.102381
= $46.88372093.

Total equity = $46.88372093 10 million shares

= $468,837,209.

19-17 a. If a U.S. based company undertakes the project, the rate of return for the project is a simple
calculation, as is the net present value.

NPV = -$1,000 + $1,200/1.14 = $52.63.

Rate of return = $1,200/$1,000 1 = 20%.

b. According to interest rate parity, the following condition holds:

Forward exchange rate 1 rSwiss
=
Spot exchange rate 1 rUS
Forward exchange rate 1.045
=
1.62 1.0725
Forward exchange rate
= 0.97436
1.62
Forward exchange rate = 1.5785 SF per U.S. $.

c. First, we must adjust the cash flows to reflect Solitaire's home currency.

Year CF ($) CF (SFrancs)

0 -1,000 -1,620.00
1 1,200 1,894.15

Using the Swiss Franc-denominated cash flows, the appropriate NPV and rate of return can be
found.

NPV = -1,620 + 1,894.15/1.14 = 41.54 Swiss Francs.

Rate of return = 1,894.15 SF/1,620 SF 1 = 16.92%.

500 Integrated Case Chapter 19: Multinational Financial Management