Foreign Exchange What is a multinational corporation?

1. Foreign ExchangeWhat is a multinational corporation? • A corporation that operates in two or more countries. • Decision making within the corporation may be: • centralized in the home country, or • decentralized across the countries the corporation does business in.

2. Why do firms expand into other countries? • To seek new markets. • To seek new sources of supply. • To seek new technology. • To seek production efficiency. • To avoid political and regulatory hurdles. • To diversify.

3. What factors distinguish multinational financial management from domestic financial management? • Different currency denominations. • Economic and legal ramifications. • Language differences. • Cultural differences. • Role of governments. • Political risk.

4. Orange juice project:Setting the appropriate price • A U.S. firm can produce a liter of orange juice and ship it to Japan for U.S. $1.75 per unit. If the firm wants a 50% markup on the project, what should the juice sell for in Japan? • Assume 111.11 yen per $U.S. • Price = (1.75)(1.50)(111.11) = 291.66 yen

5. Orange juice project:Determining profitability The product will cost 250 yen to produce in Japan and ship to Australia, where it can be sold for $6 Australian. What is the $U.S. profit on the sale? • Assume ¥1 = $A0.0138 • Cost in $A = ¥250 X (0.0138) = $A3.45 • $A profit = 6 – 3.45 = $A2.55 • $U.S. profit = 2.55/1.5385 = $U.S.1.66

6. What is exchange rate risk? • The risk that the value of cash in one currency translated to another currency will decline due to a change in exchange rates. • For example, in the last slide, an Australian dollar weakening against the yen would lower the $A profit – and the $U.S. profit. • The current international monetary system is mainly a floating rate system.

7. Current Events • UK (England) voted to leave EU • Concern about EU laws and regulation • Concern about immigrants • Concern about economy and jobs. • UK never in EMU (Pound, not Euro)

8. European Monetary Union • In 2002, the full implementation of the “euro” was completed. • The national currencies of the 12 participating countries were phased out in favor of the “euro.” • The newly formed European Central Bank controls the monetary policy of the EMU.

9. Original nations of the EMU • Austria • Belgium • Finland • France • Germany • Greece • Ireland • Italy • Luxembourg • Netherlands • Portugal • Spain Notable European Union countries not in the EMU: • Britain, Sweden, and Denmark

10. 19 Nations of the EMU, 2016 • Italy • Latvia • Lithuania • Luxembourg • Malta • Netherlands • Portugal • Slovakia • Slovenia • Spain • Austria • Belgium • Cyprus • Estonia • Finland • France • Germany • Greece • Ireland

11. Member nations of the EU • Italy • Latvia • Lithuania • Luxembourg • Malta • Netherlands • Poland • Portugal • Romania • Slovakia • Slovenia • Spain • Sweden • United Kingdom • Austria • Belgium • Bulgaria • Croatia • Cyprus • Czech Republic • Denmark • Estonia • Finland • France • Germany • Greece • Hungary • Ireland

12. Turkey • Applied to join EU • Not currently member nation

13. OandA.com • The exchange rate between any two currencies. • Current and historical. • Excellent source of Exchange rates

14. What is a convertible currency? • A currency is convertible when the issuing country promises to redeem the currency at current market rates. • Convertible currencies are traded in world currency markets.

15. What problems may arise when a firm operates in a country whose currency is not convertible? • It becomes difficult for multi-national companies to conduct business because there is no easy way to take profits out of the country. • Often, firms will barter for goods to export to their home countries.

16. What is difference between spot rates and forward rates? • Spot rates are the rates to buy currency for immediate delivery. • Forward rates are the rates to buy currency at some agreed-upon date in the future.

17. When is the forward rate at a premium to the spot rate? • If the U.S. dollar buys fewer units of a foreign currency in the forward than in the spot market, the foreign currency is selling at a forward premium. • In the opposite situation, the foreign currency is selling at a forward discount. • The primary determinant of the spot/forward rate relationship is expected relative interest rates.

18. What impact does relative inflation have on interest rates and exchange rates? • Lower inflation leads to lower interest rates, so borrowing in low-interest countries may appear attractive to multinational firms. • However, currencies in low-inflation countries tend to appreciate against those in high-inflation rate countries, so the effective interest cost increases over the life of the loan.

19. Impact of multinational operations • Capital budgeting decisions • Foreign operations are taxed locally, and then funds repatriated may be subject to U.S. taxes. • U.S. allows a tax credit for foreign taxes paid. • Foreign projects are subject to political risk. • Funds repatriated must be converted to U.S. dollars, so exchange rate risk must be taken into account.