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Chapter 9Multinational Treasury Management

Learning objectives

Setting financial goals and strategies

Managing operations Managing international trade

Financing international trade

Managing the firms cash flows

Currency risk management

Currency exposures and forward hedges

Implementing a risk management policy

Butler, Multinational Finance, 4e

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Functions of the modern treasury

Treasury serves as a corporate bank

- Determine the firms overall financial goals

- Manage the risks of domestic and internationaltransactions

- Arrange financing for domestic and internationaltrade

-Consolidate and manage financial flows

- Identify, measure, and manage riskexposures


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Setting financial goals & strategies

Identify the firms core competencies andpotential growth opportunities

Evaluate the business environment within

which the firm operates

Formulate a strategicplan for achievingsustainable competitive advantages

Develop processes for implementing thestrategic business plan


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The problems of international trade

Exporters must assure timely payment

Importers must assure timely delivery of

quality goods

Geographic and cultural distances aregreater than in domestic trade

Trade disputes span several legaljurisdictions

Managing international trade

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Murphys Law applies to

international business

If something can go wrong, itwill.


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Managing the risksof international shipments

Trade documentationreduces exposures tooperating and financial risks

- Commercial invoice - Packing list

- Certificate of origin - Export declaration

- Export license - Bill of lading

- Dock receipt - Warehouse receipt

- Insurance certificate - Inspection certificate

Freight forwarders (shippers)

can coordinate the logistics of trade


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International payment methods

Cash in advance

- Buyer pays for goods prior to shipment

- Buyer provides the financing

Open account

- Seller delivers goods and bills buyer underagreed-upon payment terms

-Receivables can be discounted or factored(sold); long-term receivables can be sold toa forfaiter


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Documentary credits

- A letter of credit(L/C) issued by the buyersbank guarantees payment upon receipt of

trade documents- In some countries, letters of credit can be

discounted or used as collateral for newborrowings

- Other countries do not follow this practice


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Documentary collection

- Sight drafts payable on demand

- Time drafts payable at specified date

Trade acceptances are drawn on andaccepted by the buyer

Bankers acceptances accepted by a

commercial bank- Trade acceptances and bankers

acceptances can be discounted


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Payment with a bankers acceptance


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All-in cost is the internal rate of return of theincremental cash flows associated with afinancing alternative

Periodic all-in cost

= (Foregone cash flow) / (Discounted value)-1

All-in cost of trade finance

Foregonecash flow

Discountedvalue


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A percent acceptance fee is charged on a1 millionbankers acceptance that is due in three months,

which is sold at a discount of 1 percent

Solution:

-The 0.5% fee is deducted at maturity, so theacceptance returns995,000 at maturity

- This acceptance can be sold today for995,000/(1.01) =985,149

The all-in cost is then (1,000,000/985,149)-1

= 1.51 percent per 3 months, or

APR = (1.0151)4-1 = 6.17 percent

All-in cost example


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Countertrade - exchange of goodsor services not involving cash

- Counterpurchase

- Offset

Delivery and payment depend on theterms of trade


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Managing multinational cash flows

Cash management- Multinational netting

- Forecasting funds needs

Relationship management- between thefirms operating divisions and external

partners

-Credit management

- Transfer pricing

- Determination of hurdle rates

Managing the MNCs cash flows

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An example of fx exposure

A U.S. firm expects to receive 40,000Polish zlotys (Z) in one year

The spot rate expected to prevail in oneyear is E[S1

$/Z] = $0.25/Z

What effect will an actual spot rate of S1$/Z

= $0.20/Z have on the firm?


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Expected receiptat E[S1

$/Z] = $0.25/Z

Actual exchange

at S1$/Z = $0.20/Z

Net loss from

original position

Risk (or payoff) profileof underlying exposure

DV$/Z

DS$/Z-$0.05/Z

-$0.05/Z

+ slope

-$2,000

+Z40,000 +$8,000 at $0.20/Z

+Z40,000

+$10,000 at $0.25/Z

An example of fx exposure


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Net currency exposure

Underlying position(long zlotys)

Sell zlotys forward

(short zlotys and long dollars)

Net position

Net exposureDV$/Z

long zlotys

DS$/Z

short zlotys

+Z40,000

+$10,000

-Z40,000

+$10,000


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Types of exposure to currency risk

Economic exposureChange in the value of all future cash flows fromunexpected changes in exchange rates

- Transaction exposureChange in the value of contractualcashflowsfrom unexpected changes in exchange rates

- Operating exposure

Change in the value of noncontractualcashflows from unexpected changes in exchangerates


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Types of exposure to currency risk

Translation (accounting) exposure

Change in financial statements fromunexpected changes in exchange rates


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Economic exposure

Real

assets

Monetaryassets

Commonequity

MonetaryLiabilities

Economic exposure

= Change in the value of all future cash flows

from unexpected changes in exchange rates= Transaction exposure + Operating exposure

Exposure of common equity

= Net monetary exposure+Operating exposure


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A survey of corporate treasurers

Transaction exposure 1.4

Operating exposure 1.8

Translation exposure 2.4

Mean score

Key: 1 = strongly agree ... 3 = neutral

5 = strongly disagree

Managing ______ is important.


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Transaction exposure is viewed by

corporate treasurers as the most importantcurrency risk exposure

Source: Jesswein, Kwok and Folks, Adoption of Innovative

Products in Currency Risk Management: Effects of ManagementOrientations and Product Characteristics, Journal of Applied

Corporate Finance(1995).

A survey of corporate treasurers


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A 5-step currency riskmanagement program

Anticipating and responding to changes inforeign exchange rates

-

Identify the distribution of future exchangerates

- Estimate the sensitivity of revenues andexpenses

-Determine the desirability of hedging

- Evaluate hedging alternatives

- Monitor the position and reevaluate


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Market-based forecasts

- Forward parity

E[Std/f] = Ftd/f

- Relative purchasing power parity

E[Std/f] = S0

d/f [(1+id)/(1+if)]t

- with equal real interest rates

E[Std/f] = S0

d/f [(1+pd)/(1+pf)]t

Exchange rate forecasting


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Model-based forecasts

- Technical analysis - uses the recent

history of exchange rates to predictexchange rates

- Fundamental analysis - uses

macroeconomic data to predictexchange rates

Exchange rate forecasting


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Risk management should complement theoverall business plan

Risk management policy

Passivemanagement

Activemanagement

Static approach Dynamicapproach

Technicalforecasts

Fundamentalforecasts


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