Multinational Financial Management

MULTINATIONAL
FINANCIAL
MANAGEMENT
SUBMITTED TO SUBMITTED BY
MS.SEEMA BHUSHRA Ashok Rana
11BBA08
FOREIGN EXCHANGE RATE
It is the rate at which one currency will be exchanged for
another in foreign exchange.
It is also regarded as the value of one country’s currency
in terms of another currency.
There are three basic types;
Fixed rate
Floating rate
Managed rate
FIXED EXCHANGE RATE
It is the system of following a fixed rate for converting
currencies.
In this system, the government (or the central bank acting
on its behalf) intervenes in the currency market in order to
keep the exchange rate close to a fixed target.
 It does not allow major fluctuations from the central rate.
FLEXIBLE EXCHANGE RATE
Under the flexible exchange rate system, the rate of
exchange is allowed to vary to suit the economic
policies of the government.
Flexible exchange rates are exchange rates, which
fluctuate according to market forces.
The value of the currency is determined solely by the
forces of demand and supply in the exchange market.
(self correcting mechanism)
MANAGED EXCHANGE RATE
Managed exchange rate systems permit the government to
place some influence on an exchange rate that would
otherwise be freely floating.
Managed means the exchange rate system has attributes
of both systems.
Through such official interventions it is possible to
manage both fixed and floating exchange rates.
Simple Mechanism of Demand & Supply
As stated earlier exchange rate is determined by its the
forces of supply and demand.
Therefore, if for some reason people increase their
demand for a specific currency, then the price will rise
provided that the supply remains stable.
 On the contrary, if the supply is increased the price will
decline and it is provided that the demand remains stable.
Purchasing Power Parity Theory
 Most widely accepted theory
“According to PPP theory, when exchange rates are of a
fluctuating nature, the rate of exchange between two
currencies in the long run will be fixed by their respective
purchasing powers in their own nations.”
 The price of a good that is charged in one country should

be equal to the one charged for the same good in another
country, being exchanged at the current rate.
This rule is also known as the law of one price.
It is an economic theory that estimates the amount of
adjustment needed on the exchange rate between countries
in order for the exchange to be equivalent to each
currency's purchasing power.
DETERMINANTS OF FOREIGN EXCHANGE
RATE
1. Interest Rate
Whenever there is an increase interest rates in domestic
market there will be increase investment funds causing a
decrease in demand for foreign currency and an increase in
supply of foreign currency.
2. Inflation Rate
when inflation increases there will be less demand for
local goods (decreased supply of foreign currency) and more
demand for foreign goods (increased demand for foreign
currency).
Types of Foreign Exchange Exposure
• Transaction exposure
• Economic exposure
• Translation exposure
Transaction Exposure
Transaction Exposure: Results from a firm taking on
“fixed” cash flow foreign currency denominated
contractual agreements.
Examples of translation exposure:
 An Account Receivable denominate in a foreign currency.
 A maturing financial asset (e.g., a bond) denominated in a foreign
currency.
 An Account Payable denominate in a foreign currency.
 A maturing financial liability (e.g., a loan) denominated in a
foreign currency.
Economic Exposure
Economic Exposure: Results from the “physical” entry
(and on-going presence) of a global firm into a foreign
market.
 This is a long term foreign exchange exposure resulting from a
previous FDI location decision.
 Over time, the firm will acquire foreign currency denominated
assets and liabilities in the foreign country.
 The firm will also have operating income and operating costs in
the foreign country.
Translation Exposure
Translation Exposure: Results from the need of a global
firm to consolidated its financial statements to include
results from foreign operations.
Consolidation involves “translating” subsidiary financial
statements from local currencies (in the foreign markets
where the firm is located) to the home currency of the firm
(i.e., the parent).
Consolidation can result in either translation gains or
translation losses.
The Balance of Payment Theory
The balance of payments approach is another method that
explains what the factors are that determine the supply and
demand curves of a country’s currency.
As it is known from macroeconomics, the balance of
payments is a method of recording all the international
monetary transactions of a country during a specific period of
time.
 The transactions recorded are divided into four categories:
the current account transactions, the capital account
transactions, financial account and the central bank
transaction.
CURRENT ACCOUNT
export and import of goods &services

CAPITAL ACCOUNT
Capital transfers
FINANCIAL TRANSFERS
Foreign direct investment

Portfolio investment
RESERVEBANK TRANSACTIONS
According to the theory, a deficit in the balance of payments
leads to fall or depreciation in the rate of exchange, while a
surplus in the balance of payments strengthens the foreign
exchange reserves, causing an appreciation in the price of
home currency in terms of foreign currency. A deficit
balance of payments of a country implies that demand for
foreign exchange is exceeding its supply.
As a result, the price of foreign money in terms of domestic
currency must rise, i.e., the exchange rate of domestic
currency must fall. On the other hand, a surplus in the
balance of payments of the country implies a greater demand
for home currency in a foreign country than the available
supply. As a result, the price of home currency in terms of
foreign money rises, i.e., the rate of exchange improves.
Country Risk Analysis
Country risk can be used:
to monitor countries where the MNC is presently doing
business;
as a screening device to avoid conducting business in
countries with excessive risk; and
to improve the analysis used in making long-term
investment or financing decisions.
Political Risk Factors
Attitude of Consumers in the Host Country
Some consumers may be very loyal to homemade
products.
Attitude of Host Government
The host government may impose special requirements
or taxes, restrict fund transfers, subsidize local firms, or
fail to enforce copyright laws.
Blockage of Fund Transfers
Funds that are blocked may not be optimally used.
Currency Inconvertibility
The MNC parent may need to exchange earnings for
goods.
War
Internal and external battles, or even the threat of war,
can have devastating effects.
Bureaucracy
Bureaucracy can complicate businesses.
Corruption
Corruption can increase the cost of conducting business
or reduce revenue.
Financial Risk Factors
Current and Potential State of the Country’s Economy
A recession can severely reduce demand.
Financial distress can also cause the government to
restrict MNC operations.
Indicators of Economic Growth
A country’s economic growth is dependent on several
financial factors - interest rates, exchange rates,
inflation, etc.
Techniques of
Assessing Country Risk
A checklist approach involves rating and weighting all
the identified factors, and then consolidating the rates
and weights to produce an overall assessment.
The Delphi technique involves collecting various
independent opinions and then averaging and
measuring the dispersion of those opinions.
Techniques of
Assessing Country Risk
Quantitative analysis techniques like regression analysis
can be applied to historical data to assess the sensitivity of
a business to various risk factors.
Inspection visits involve traveling to a country and
meeting with government officials, firm executives,
and/or consumers to clarify uncertainties.
What is Eurocurrency?
Eurocurrency is the term used to describe deposits
residing in banks that are located outside the borders of
the country that issues the currency the deposit is
denominated in.
For example: a deposit denominated in US dollars residing
in a Japanese bank is a Eurocurrency deposit, or more
specifically a Eurodollar deposit.
Features of Eurocurrency Market
1. It is an international market and it is under no national
control: It has come up as the most important channel for
mobilizing and deploying funds on an international scale.
2. It is a short term money market:
3. Eurodollar markets are the time-deposit market. The
deposits here have a maturity period ranging one day to
several months. Eurodollar is the short-term deposit. It is
a wholesale market:
 It is so because Eurodollar is the currency that is dealt in only
large units.
 Size of individual transaction is usually above $1million.
4. It is highly competitive and sensible market:
High competitive: This market is characterized as
highly competitive because the market is growing
and accepted internationally.
Sensible: The Eurodollar market is said to be

sensible because it responds faster to the changes in
demand and supply of the funds and also reacts to
changes in the interest rates.
Participants in Eurocurrency Market
1. Government
2. International Organizations
3. Central Banks
4. Commercial Banks
5. Corporations
6. MNC
7. Traders
8. Individuals
Participants have contributed in the demand and supply of
the fund, in the following way:
Supply:
1. Central Banks of various countries are the suppliers; they
channel the fund through BIS.
2. Increase in the Oil Revenue of the OPEC has added to
the fund.
3. MNCs and the traders place their surplus funds for the
short-term gains.
Demand:
4. Government demand for these funds to meet the deficit
arising due to meet the deficit arising due to the deficit
in Balance of Payment and the rise in the oil prices.
5. Commercial Banks needs extra fund for lending.
Some also borrow for the better ‘window dressing’ in the
year-end.
Advantages
1. It helped the economies to solve the liquidity problems:
2. It provided better investment opportunities.
3. Funds are also by the commercial banks of various
countries for domestic credit creation and window
dressing.
4. This facilitated the growth and development of various
countries like Brazil, South Korea, Taiwan, and Mexico
etc…
5. Its International acceptance has helped in the
international trade to expand and accelerated the
process of globalization.
Disadvantages
1. For many economies it is a new concept.
2. For many economies also considered that the

speed of its growth or expansion is TOO fast.
3. For many economies, they feel this market

gives a chance to avoid many a regulations
that they try to impose on their national
money market.

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MULTINATIONAL

 The price of a good that is charged in one country should

export and import of goods &services

Foreign direct investment

Sensible: The Eurodollar market is said to be

2. For many economies also considered that the

3. For many economies, they feel this market

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