Chapter 9

Multinational 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 9-1

Functions of the modern treasury

Treasury serves as a corporate bank

- Determine the firms overall financial goals
- Manage the risks of domestic and international transactions

- Arrange financing for domestic and international trade

- Consolidate and manage financial flows

- Identify, measure, and manage risk exposures

Setting financial goals and strategies

9-2

Setting financial goals & strategies

Identify

the firms core competencies and potential growth opportunities the business environment within which the firm operates

Evaluate

Formulate

a strategic plan for achieving sustainable competitive advantages

processes for implementing the strategic business plan

Develop

Setting financial goals and strategies

9-3

The problems of international trade

Exporters must assure timely payment Importers must assure timely delivery of quality goods

Geographic and cultural distances are greater than in domestic trade

Trade disputes span several legal jurisdictions

Managing international trade

9-4

Murphys Law applies to international business

If something can go wrong, it will.

Managing international trade

9-5

Managing the risks of international shipments

Trade documentation reduces exposures to operating and financial risks

- Commercial invoice - Certificate of origin - Export license - Dock receipt - Insurance certificate - Packing list - Export declaration - Bill of lading - Warehouse receipt - Inspection certificate

Freight forwarders (shippers) can coordinate the logistics of trade

9-6

Managing international trade

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 under agreed-upon payment terms - Receivables can be discounted or factored (sold); long-term receivables can be sold to a forfaiter

Financing international trade

9-7

International payment methods

Documentary

credits

- A letter of credit (L/C) issued by the buyers bank guarantees payment upon receipt of trade documents - In some countries, letters of credit can be discounted or used as collateral for new borrowings - Other countries do not follow this practice

Financing international trade

9-8

International payment methods

Documentary

collection

- Sight drafts payable on demand - Time drafts payable at specified date acceptances are drawn on and accepted by the buyer Bankers acceptances accepted by a commercial bank - Trade acceptances and bankers acceptances can be discounted
Financing international trade 9-9

Trade

Payment with a bankers acceptance

Financing international trade

9-10

All-in cost of trade finance

All-in

cost is the internal rate of return of the incremental cash flows associated with a financing alternative
Discounted value Foregone cash flow

Periodic all-in cost = (Foregone cash flow) / (Discounted value)-1

Financing international trade 9-11

All-in cost example

A percent acceptance fee is charged on a 1 million bankers 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 the acceptance returns 995,000 at maturity - This acceptance can be sold today for 995,000/(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
Financing international trade 9-12

International payment methods

Countertrade

- exchange of goods or services not involving cash

-

Counterpurchase

Offset

Delivery

and payment depend on the terms of trade

Financing international trade

9-13

Managing multinational cash flows

Cash

management

- Multinational netting - Forecasting funds needs

Relationship

management - between the firms operating divisions and external partners

- Credit management

- Transfer pricing
- Determination of hurdle rates
Managing the MNCs cash flows 9-14

An example of fx exposure

A U.S. firm expects to receive 40,000 Polish zlotys (Z) in one year
The spot rate expected to prevail in one year is E[S1$/Z] = $0.25/Z What effect will an actual spot rate of S1$/Z = $0.20/Z have on the firm?

Currency risk management

9-15

An example of fx exposure
Expected receipt at E[S1$/Z] = $0.25/Z +Z40,000 +$10,000 at $0.25/Z

Actual exchange at S1$/Z = $0.20/Z

Net loss from original position

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

-$2,000

DV$/Z
Risk (or payoff) profile of underlying exposure

+ slope
-$0.05/Z

DS$/Z
-$0.05/Z

Currency risk management

9-16

Currency hedging with forwards

Buy $10,000 forward at F1$/Z = $0.25/Z Sell Z40,000 forward +$10,000

-Z40,000
+$8,000 -Z40,000 +$2,000

Market exchange of Z for $ at S1$/Z = $0.20/Z Net gain on forward Risk profile of a forward contract

- slope
-$0.05/Z

DV$/Z
+$0.05/Z

DS$/Z
9-17

Currency risk management

Net currency exposure

Underlying position (long zlotys) Sell zlotys forward (short zlotys and long dollars) Net position Net exposure
short zlotys

+Z40,000

+$10,000 -Z40,000 +$10,000

DV$/Z
long zlotys

DS$/Z

Currency risk management

9-18

Types of exposure to currency risk

Economic

exposure

Change in the value of all future cash flows from unexpected changes in exchange rates

- Transaction exposure
Change in the value of contractual cash flows from unexpected changes in exchange rates

- Operating exposure
Change in the value of noncontractual cash flows from unexpected changes in exchange rates
Currency risk management 9-19

Types of exposure to currency risk

Translation (accounting) exposure

Change in financial statements from unexpected changes in exchange rates

Currency risk management

9-20

Economic exposure
Monetary assets Real assets Monetary Liabilities

Common equity

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
Currency risk management 9-21

A survey of corporate treasurers

Managing ______ is important.
Mean score 1.4 1.8 2.4

Transaction exposure Operating exposure Translation exposure

Key: 1 = strongly agree ... 3 = neutral 5 = strongly disagree
Currency risk management

9-22

A survey of corporate treasurers

Transaction exposure is viewed by corporate treasurers as the most important currency risk exposure
Source: Jesswein, Kwok and Folks, Adoption of Innovative Products in Currency Risk Management: Effects of Management Orientations and Product Characteristics, Journal of Applied Corporate Finance (1995).

Currency risk management

9-23

A 5-step currency risk management program

Anticipating

and responding to changes in foreign exchange rates

- Identify the distribution of future exchange rates - Estimate the sensitivity of revenues and expenses - Determine the desirability of hedging - Evaluate hedging alternatives - Monitor the position and reevaluate

Currency risk management

9-24

Exchange rate forecasting

Market-based -

forecasts

Forward parity E[Std/f] = Ftd/f Relative purchasing power parity E[Std/f] = S0d/f [(1+id)/(1+if)]t

with equal real interest rates E[Std/f] = S0d/f [(1+pd)/(1+pf)]t

9-25

Currency risk management

Exchange rate forecasting

Model-based -

forecasts

Technical analysis - uses the recent history of exchange rates to predict exchange rates Fundamental analysis - uses macroeconomic data to predict exchange rates

Currency risk management

9-26

Risk management should complement the overall business plan

Risk management policy

Passive management

Active management

Static approach

Dynamic approach

Technical forecasts

Fundamental forecasts

Currency risk management

9-27