Download Compensating Balances

Multinational Financial Management
Alan Shapiro
10th Edition
John Wiley & Sons, Inc.
PowerPoints by
Joseph F. Greco, Ph.D.
California State University, Fullerton
1
CHAPTER 19
Current Asset Management
and Short-Term Financing
PART 1
International Cash
Management
INTERNATIONAL CASH
MANAGEMENT
I.
INTERNATIONAL CASH MANAGEMENT
A. Seven Key Areas Involve Issues about
1. Organization
2. Collection/Fund Disbursement
3. Interaffiliate Payments
4. Investment of Excess Funds
5. Optimal Global Cash Balances
6. Cash Planning/Budgeting
7. Bank Relations
INTERNATIONAL CASH
MANAGEMENT
B.
Goals of an International Cash
Manager: similar to domestic manager
1. Quick and efficient cash control
2. Optimal conservation and usage
response
INTERNATIONAL CASH
MANAGEMENT
Issue (#1): Centralize Organization
1. Advantages:
a. Efficient liquidity levels
b. Enhanced profitability
c. Quicker headquarter
INTERNATIONAL CASH
MANAGEMENT
1. Advantages (con’t)
d.
e.
f.
g.
Decision making enhanced
Better volume currency
quotes
Greater cash management
expertise
Less political risk
INTERNATIONAL CASH
MANAGEMENT
Issue (#2): Collection/Disbursement of
Funds
1. Key Element: Accelerate collections
2. Acceleration Methods:
a.
Electronic fund transfers
b.
Mobilization centers
INTERNATIONAL CASH
MANAGEMENT
3. Methods to Expedite Cash Payments
a. Wire cash transfers
b. Establish accounts in client’s bank
c. Negotiate with banks
- obtain value dating
INTERNATIONAL CASH
MANAGEMENT
Issue (#3): Interaffiliate Payments:
Use Payments Netting
1.
Definition:
-offset payments of affiliate
receivables/payables
-net amounts only are transferred.
INTERNATIONAL CASH
MANAGEMENT
2. Create Netting Center
a. set up a subsidiary in a location
with minimal exchange controls
b. Coordinate interaffiliate payment
flows
c. Netting Center’s value:
a direct function of the volume of
transfers
INTERNATIONAL CASH
MANAGEMENT
Issue (#4): Excess Fund Investment
1. Major task:
a.
b.
determine minimum cash
balances
short-term investment of
excess balances
INTERNATIONAL CASH
MANAGEMENT
2. Requirements:
a.
Forecast of cash needs
b.
Knowledge of minimum cash position
INTERNATIONAL CASH
MANAGEMENT
3. Investment Selection Criteria:
a.
Degree of Government regulations
b.
c.
Market structure
Leniency of Foreign tax laws
INTERNATIONAL CASH
MANAGEMENT
Issue (#5) Optimal Global Cash
Balances
1. Establish centrally managed cash pool
2. Require affiliates to hold minimum amounts
INTERNATIONAL CASH
MANAGEMENT
3. Benefits of Optimal Global Cash
Balances
a.
b.
c.
d.
Less outside borrowing needed
More excess fund for investment
Reduced internal expense
Reduced currency exposure
INTERNATIONAL CASH
MANAGEMENT
Issue (#6) Cash Planning and
Budgeting
INTERNATIONAL CASH
MANAGEMENT
Issue (#7) Bank Relations
1. Good Relations Will Avoid
a. Lost interest income
b. Overpriced services
c. Redundant services
INTERNATIONAL CASH
MANAGEMENT
2. Common Bank Relations Problems
a. Too many banks
b. High costs
such as compensating balances
c. Inadequate reporting
d. Excessive clearing delays
ACCOUNTS RECEIVABLE
MANAGEMENT
II.
ACCOUNTS RECEIVABLE MANAGEMENT
A. Trade Credits
extended in anticipation of profit by
1. expanded sales volume
2. retaining existing customers
ACCOUNTS RECEIVABLE
MANAGEMENT
B.
Credit Terms Should Consider
1.
2.
Sales force
customer selection criteria
Adjusting sales bonuses for cost
of credit sales.
INVENTORY MANAGEMENT
III.
INVENTORY MANAGEMENT
A. Problems:
MNCs seem to have more difficulties due to
1. Long, variable transits
2. Lengthy customs procedures
INVENTORY MANAGEMENT
B.
Issue: Production Location
1.
Overseas location may lead to
higher inventory carrying costs
due to
a.
larger amounts of work-inprocess
b.
more finished goods
INVENTORY MANAGEMENT
C.
Subsidiary Practice known as:
Advanced Inventory Purchases or inventory
stockpiling
INVENTORY MANAGEMENT
D.
E.
Reason for Stockpiling:
reduce risk of shipping delays
Results of Stockpiling:
Higher carrying costs
Solution to higher carrying costs:
Adjust affiliate’s profit margins to reflect
added costs.
CHAPTER 19 PART 2
Short-Term Financing
SHORT-TERM FINANCING
IV.
SHORT-TERM FINANCING
A. Strategy
1. Identify: 3 key factors
2. Formulate/evaluate:
objectives
3. Describe: available options
4. Develop a methodology:
to calculate/compare costs
EIR = The Effective Interest Rate
SHORT-TERM FINANCING
B.
Key Factors
1. Deviations from Int’l Fisher Effect?
a. If yes
trade-off required between cost and
exchange risk
b. If no
costs are same everywhere
SHORT-TERM FINANCING
2. Does Interest Rate Parity Hold?
a. Yes. Currency is irrelevant.
b. No. Cover costs may differ
-added risk may mean the
forward premium/discount does
not offset interest rate
differentials.
SHORT-TERM FINANCING
3. Political Risk: If high,
a.
MNCs should
1.)
maximize local financing.
2.)
Faced with confiscation
or currency controls,
fewer assets at risk
SHORT-TERM FINANCING
OBJECTIVES
C. Short-Term Financing Objectives
1. Possible Objectives:
a.
Minimize expected cost
b.
Minimize risk without regard to cost
SHORT-TERM FINANCING
OBJECTIVES
D.
Short-Term Financing Options
1.
Three Possibilities
a.
Inter-company loans
b.
Local currency loans
c.
Euro market
SHORT-TERM FINANCING
OBJECTIVES
2. Local Currency Financing: Bank Loans
a. Short-term in nature
b. Forms of Local Currency bank loans
1.)
Term loans
2.)
Line of credit
3.)
Discounting
EFFECTIVE INTEREST RATE
3. Calculating Interest Costs
a. Effective interest rate (EIR):
- most efficient measure of cost
b. Basic formula:
EIR = Annual Interest Paid
Funds Received
EFFECTIVE INTEREST RATE
Sample Problem #1
Pro Logic Co. receives a loan for $10,000 at 11%
interest payable at maturity at the end of one year.
What is the EIR?
EIR =
=
$1,100
$10,000
11%
(10,000x.11)
10,000
EFFECTIVE INTEREST RATE
Sample Problem #2
Discounting the loan
Pro Logic Co. receives a loan for $10,000 at 11% on a
discounted basis for one year. What is the EIR?
EIR
=
=
=
$1,100
$8,900
1100
8900
12.4%
(10,000x.11)
10,000-1100
EFFECTIVE INTEREST RATE
Sample Problem #3: Compensating Balances
Pro Logic Co. receives a loan for $10,000 at 11% with a
15% compensating balance requirement for one year.
What is the EIR?
EIR
=
=
=
$1,100
$8,500
1100
8500
12.9%
(10,000x.11)
10,000-1500
EFFECTIVE INTEREST RATE
Sample Problem #4: CompensatingBalance
on a discounted loan
Pro Logic Co. receives a loan for $10,000 at 11%
on a discounted basis and a 15% compensating
balance requirement for one year. What is the
EIR?
EIR =
$1,100
$7,400
=14.9%
(10,000x.11)
10,000-1100-1500
COMMERCIAL PAPER
4. Non-bank lending : Commercial Paper
a. Definition:
short-term unsecured promissory
note generally sold by large MNCs
on a discount basis.
b. Standard maturities
c. Bank fees charged for:
1.)
Backup line of credit
2.)
Credit rating service
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