Slide 0Slide 1Chapter OutlineThe Management of International Cash BalancesThe Size of Cash BalancesSlide 6Choice of CurrencyWhere Cash Balances are Located.Netting: Bilateral and MultilateralExposure Netting: an ExampleSlide 11Multilateral Netting: an ExampleNetting with Central DepositorySlide 14Slide 15Reduction in Precautionary Cash BalancesCash Management Systems in PracticeExposure Netting Sample ProblemSlide 18Slide 19Slide 20Slide 21End Chapter NineteenINTERNATIONALFINANCIALMANAGEMENTEUN / RESNICKFifth EditionCopyright © 2009 by The McGraw-Hill Companies, Inc. All rights reserved. McGraw-Hill/IrwinFifth EditionChapter Objective:This chapter discusses various issues associated with multinational cash management.19 Chapter NineteenMultinational Cash Management19-2Chapter OutlineThe Management of Multinational Cash BalancesBilateral Netting of Internal and external Net Cash FlowsReduction in Precautionary Cash FlowsCash Management Systems in Practice19-3The Management of International Cash BalancesThe size of cash balances The currency denominationWhere these cash balances are located19-4The Size of Cash BalancesThe optimal size of the firm’s cash balances depend upon:The cost of keeping “too much” cash on hand. i.e. the opportunity costs of holding cashThe cost of not keeping enough cash on hand.i.e. the trading costs associated with having too little cashThe variability of cash flows.19-5The Size of Cash BalancesOpportunity CostsTrading costsTotal cost of holding cashC*Costs in dollars of holding cashSize of cash balanceThe investment income foregone when holding cash.Trading costs increase when the firm must sell securities to meet cash needs.19-6Choice of CurrencyBy maintaining cash balances in a particular currency, the MNC is essentially speculating (or hedging?) in that currency.19-7Where Cash Balances are Located.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?19-8Netting: Bilateral and MultilateralMultilateral Netting Is an efficient and cost-effective mechanism for settling interaffiliate foreign exchange transactions.Not all countries allow MNCs to net paymentsBy limiting netting, more unnecessary foreign exchange transactions flow through the local banking system.19-9Exposure Netting: an ExampleConsider a U.S. MNC with three subsidiaries and the following foreign exchange transactions ($000s):$10$35$40$30$20$25 $60$40$10$30$20$3019-10Exposure Netting: an ExampleBilateral Netting would reduce the number of foreign exchange transactions by half:$10$35$40$30$20$40$30$20$30$20$30$10$40$30$10$30$20$60$10$35$25$60$40$20$25 $10$25 $10$15 $1019-11Multilateral Netting: an ExampleConsider simplifying the bilateral netting with multilateral netting:$25$10$20$10$10$10$15 $10$10$30$15 $10$10$40$15$15 $40$40$15 19-12Netting with Central DepositorySome firms use a central depository as a cash pool to facilitate funds mobilization and reduce the chance of misallocated funds.$15 $40Central depository$5519-13Netting with Central DepositoryConsider the net cash flows of the affiliates with the rest of the world:Affiliate Net Receipts from Multilateral NettingNet Excess Cash from Transactions with Third PartiesNet FlowU.S. $55,000 $20,000 $35,000Canada ($15,000) ($30,000) $15,000Germany 0 $75,000 ($75,000)U.K. ($40,000) ($25,000) ($15,000)Total ($40,000)19-14Netting with Central DepositoryNet cash flows after multilateral netting and net payments from external transactions Central depository$75$15$15$3519-15Reduction in Precautionary Cash BalancesAn additional benefit of a centralized cash depository is that the MNC’s investment in precautionary cash balances can be substantially reduced without a reduction in its ability to cover unforeseen expenses.In the above examples, suppose that each affiliate had to have the cash on hand to make disbursements before it received what it was owed—that would result in a big cash drain on the firm.19-16Cash Management Systems in PracticeThe most frequently cited benefits of a multilateral netting system are:1. The decrease in the expense associated with funds transfer, which in some cases can be over $1,000 for a large international transfer of foreign exchange.2. The reduction in the number of foreign exchange transactions and the associated cost of making fewer but larger transactions.3. The reduction in intracompany float, which is frequently as high as five days even for wire transfers.4. The savings in administrative time.5. The benefits that accrue from the establishment of a formal information system, which serves as the foundation for centrally managing transaction exposure and the investment of excess funds.19-17Exposure Netting Sample ProblemIn the following slides, a firm faces the following exchange rates:£1.00 = $2.00€1.00 = $1.50SFr 1.00 = $0.90Beginning with the next slide, try to use multilateral netting to reduce the number of transactions as much as possible.19-18€150€150£150£150$150$150SFr150SFr150£150$150SFr150€150Exposure Netting19-19€150€150£150£150$150$150SFr150SFr150£150$150SFr150€150SFr150×SFr1$0.90= $135$135$135$135£150×£1$2.00= $300$300$300$300€150×€1$1.50= $225$225$225$225$225$225$300$300$150$150$135$135$300$150$135$225Exposure Netting19-20$225$225$300$300$150$150$135$135$300$150$135$225$15$75$75$165$90$150$75$165$90$150$75$15Exposure Netting19-21$75$165$90$150 + $75 = $225$75$15$150$225 = $210 + $15$15$210$180 = $165 + $15$180$180$90$210Exposure Netting19-22End Chapter