CURRENT ASSET MANAGEMENT AND SHORT-TERM FINANCING
This chapter discusses the management of cash, accounts receivable and inventory in the multinational corporation,
as well as the financing of these current assets. The chapter's first section provides important institutional material on
international cash management, an area which accounts for a sizable amount of a multinational treasurer's time. I go
over this material quickly, emphasizing only the unique international aspects, particularly the tax and currency control
factors, netting, and the different money market instruments available. My main objective is to have students think of
money management from a global perspective. I then point out the various ways in which multinational banks can aid
in international money management. Most of the large banks provide such services and have brochures describing their
efforts. I discuss the next two sections quickly as well, emphasizing only the more international aspects of inventory
and receivables management. These include the element of currency risk, the possibility of shortages due to exchange
controls and dockworker strikes, and the use of factoring.
The section on short-term financing discusses the alternative financing options available to companies. It emphasizes
how exchange rate changes affect the home currency costs of borrowing in different currencies. The domestic analogy
is calculating real borrowing costs, factoring in inflation and nominal interest rates. In this edition, I have deleted
discussion of how taxes affect relative borrowing costs. This material will stay in Multinational Financial Management.
The key points on short-term financing include the following:
1. In formulating a borrowing strategy, the key factors and objectives associated with that strategy must be consistent
with our understanding of the way in which financial markets work.
2. If forward contracts exist, then the only valid objective of a borrowing strategy is to minimize covered after-tax
3. In the absence of forward contracts, firms can either attempt to minimize expected costs or establish some trade-off
between reducing expected costs and reducing the degree of cash flow exposure. The latter goal involves offsetting
operating cash inflows in a currency with financing cash outflows in that same currency. In general, the borrowing
decision should be integrated with the hedging decision.
SUGGESTED ANSWERS TO CHAPTER 19 QUESTIONS
1. High interest rates put a premium on careful management of cash and marketable securities.
a. What techniques are available to an MNC with operating subsidiaries in many countries to economize on these
ANSWER . Some of the techniques are available to an MNC with operating subsidiaries in many countries to
economize on cash and marketable securities include cash pooling, bilateral and multilateral netting, multinational cash
mobilization, accelerating collections via direct debiting and lockboxes, and treasury workstations to track the firm's
cash position on a real-time basis.
b. What are the advantages and disadvantages of centralizing the cash management function?
262 INSTRUCTORS MANUAL: FOUNDATIONS OF MULTINATIONAL FINANCIAL MANAGEMENT, 4TH ED.
ANSWER . The advantages described in the book of centralizing the cash management function include:
1. The corporation can operate with a smaller amount of cash; pools of excess liquidity are absorbed and
eliminated. Each operation will maintain transactions balances only and not hold speculative or precautionary
2. By reducing total assets, financing costs are reduced and profitability is enhanced.
3. The headquarters staff, with its purview of all corporate activity, can recognize problems and opportunities
that an individual unit might not perceive.
4. All decisions can be made using the overall corporate benefit as the criterion.
5. By increasing the volume of foreign exchange and other transactions done through headquarters, banks
provide better FX quotes and better service.
6. Greater expertise in cash and portfolio management exists if one group is responsible for these activities.
7. The corporation's total assets at risk in a foreign country can be reduced. Less will be lost in the event of
expropriation or the promulgation of regulations restricting the transfer of funds.
The principal disadvantage of centralization is that it entails both explicit and implicit costs. The explicit continuing
costs relate to the added management time and expanded communications necessitated by the centralized management.
There are also costs of a more implicit nature, which relate to the behavioral problems resulting from more centralized
control. Affiliates might resent the tighter control necessary. In addition, rigid centralization provides no incentive for
local managers to take advantage of specific opportunities that only they may be aware of.
c. What can the firm do to enhance the advantages and reduce the disadvantages described in part b?
ANSWER . First, companies must respond to problems that arise with skill and tact. More important, firms must change
the way in which they evaluate the performance of local managers so as to align their best interests with the companies
best interests. For example, instead of just relieving local managers of profit and loss responsibility for their cash and
marketable securities portfolio, the firm can present local managers with interest rates for borrowing or lending funds
to the pool which reflect the opportunity cost of money to the parent corporation. By examining these internal interest
rates (IIRs), local treasurers will have a greater awareness of the opportunity cost of their idle cash balances as well
as an added incentive to act on this information. In many instances, they will prefer to transfer at least part of their cash
balances (where permitted) to a central pool in order to earn a greater return. Due to tax factors or exchange controls,
the actual interest paid or charged to the foreign affiliates may differ from the internal rates that they are evaluated on.
To make pooling of funds work, managers must have access to the central pool whenever they need cash.
2. Standard advice given to firms exporting to soft currency countries is to invoice in their own currency. Critically
analyze this recommendation and suggest a framework that will help a financial manager to decide whether or not
to stipulate hard-currency invoicing in export contracts.
a. Under what circumstances does this advice make sense?
ANSWER . The reason for advising firms exporting to soft currency countries to invoice in their own currency is to
protect against currency risk. Since this policy just shifts the risk of exchange rate changes onto the shoulders of
importers, this advice is unwarranted unless the importer is better able to bear the currency risk or the importer has not
factored currency change expectations into the price he is willing to pay. Neither of these conditions is likely to hold.
CHAPTER 19: CURRENT ASSET MANAGEMENT AND SHORT-TERM FINANCING 263
Firms can set prices in the local currency and then use a variety of hedging techniques to eliminate the resulting
transaction exposure. If forward contracts are unavailable, the firm must decide whether to bear the currency risk or
shift it to the importer. In a competitive environment, the odds are that another exporter will be willing to bear the
currency risk. Pricing in the home currency makes sense if the local currency is subject to exchange controls or if the
importer has access to forward contracts at preferential rates.
b. Are these circumstances consistent with market efficiency?
ANSWER . No. Currency controls and favorable forward rates both indicate government intervention in financial
c. Are there any circumstances under which importer and exporter will mutually agree on an invoicing currency?
ANSWER . Suppose a Brazilian firm and an Argentine firm are doing business together. Given volatile exchange rates
and rates of inflation and the absence of forward contracts between the two countries, pricing in cruzeiros or in australs
will subject both parties to either inflation risk or exchange risk. Neither party will know what the purchasing power
of the currency received or paid out will be at the time of settlement. In this case, both firms will probably agree to do
business in U.S. dollars, since the dollar will maintain a more stable purchasing power in both countries.
3. Suppose a subsidiary is all-equity financed and, hence, has no interest expenses. Does it still make sense to charge
local managers for the working capital tied up in their operations? Explain.
ANSWER . Yes. Otherwise, the subsidiary's management is not motivated to carefully scrutinize the level of working
capital to trade off its costs and benefits. The point is that working capital has an opportunity cost regardless of how
it is financed and managers should be charged for the cost of capital tied up in all the assets they use. In this way,
subsidiary managers will be more likely to weigh the costs of adding to working capital against its benefits.
4. Comment on the following statement: "One should borrow in those currencies expected to depreciate and invest
in those expected to appreciate."
ANSWER . A firm's borrowing strategy should depend on its objectives. Various tax asymmetries, such as the ones
described in the answer to question #2 could cause expected after-tax costs to be lower in depreciating currencies. In
the absence of tax asymmetries, however, or other market imperfections, it shouldn't matter from the standpoint of
minimizing expected costs whether one borrows depreciating or appreciating currencies.
Indeed, if the objective is to give advice on how to minimize expected financing costs, this statement is wrong. It
contradicts the efficient markets notion that there is no free lunch in the financial markets. According to the
international Fisher effect, currencies expected to depreciate carry higher interest rates, while those expected to
appreciate carry lower interest rates. Thus, the policy recommended here will only succeed if depreciating currencies
consistently depreciate more than expected and appreciating currencies consistently appreciate more than expected.
By definition, these conditions cannot hold over time. From the standpoint of exchange risk management, it will make
a difference in which currencies a firm borrows or lends. But we saw in Chapters 10-11 that where exchange risk
management is a consideration, the appropriate currencies to borrow or lend in depend on the firm's cash flow pattern
and its market and cost structure and not whether a particular currency is strong or weak.
5. How can taxes affect the choice of currency denomination for loans?
ANSWER . The currency denomination of corporate borrowings matters where tax asymmetries are present. These tax
asymmetries are based on the differential treatment of FX gains and losses on either forward contracts or loan
repayments, e.g., the British policy of taxing exchange gains on foreign currency borrowings but disallowing the
deductibility of exchange losses on the same loans, or the past U.S. policy of permitting exchange gains on forward
contracts to be taxed at a lower rate than the rate at which forward contract losses are deductible. Such tax asymmetries
lead to possibilities of borrowing arbitrage, even if interest rate parity holds before tax.
264 INSTRUCTORS MANUAL: FOUNDATIONS OF MULTINATIONAL FINANCIAL MANAGEMENT, 4TH ED.
6. How can the choice of currency denomination of loans enable a firm to reduce its exchange risk?
ANSWER . The risks associated with borrowing in a specific currency are related to the firm's degree of exposure in
that currency. By borrowing locally, a firm can create an offsetting liability for its exposed LC assets and thereby
reduce its currency risk. On the other hand, borrowing a foreign currency in which the firm has no exposure will
increase its exchange risk. What matters is the covariance between the operating and financing cash flows.
7. What are the three basic types of bank loans? Describe their differences.
ANSWER . The major forms of bank financing include overdrafts, discounting, and term loans. Term loans are straight
loans, often unsecured, that are made for a fixed period of time, usually 90 days. Rather than a one-time loan, like a
term loan, an overdraft is a line of credit against which drafts (checks) can be drawn (written) up to a specified
maximum amount. The discounting of trade bills is the preferred short-term financing technique in many European and
Latin American countries. A manufacturer takes a trade bill--reflecting goods sold on credit to a retailer--to his or her
bank, and the bank accepts it for a fee if the buyer's bank has not already accepted it. The bill is then sold at a discount
to the manufacturer's bank or to a money market dealer.
8. How does each of the following affect the relationship of stated and effective interest rates?
a. The lending bank requires the borrower to repay principal and interest at the end of the borrowing period only.
ANSWER . The stated and effective interest rates are the same.
b. Interest is deducted from the amount borrowed before the borrower receives the proceeds.
ANSWER . The effective interest rate exceeds the stated rate because the borrower does not have use of the full loan
c. What is the likely ranking of the above from least to most expensive?
ANSWER . Given the same stated interest rate, the likely ranking from least to most expensive is a, b.
9. Explain the characteristics of commercial paper that tend to limit its use to financially sound firms.
ANSWER . The commercial paper market has generally been dominated by the largest, most creditworthy companies
because CP is a short-term unsecured promissory note that bears only the name of the issuer.
SUGGESTED SOLUTIONS TO CHAPTER 19 PROBLEMS
1. A $1.5 billion Italian multinational manufacturing company has a total of $600 million in intercompany trade flows
and settles accounts in 13 currencies. It also has about $400 million in third- party trade flows. Intercompany
settlements are all made manually, there are no predefined remittance channels for either intercompany or
third-party payments, and the methods and currencies of payment are determined by each unit independently of
the other units. Payment terms for both intercompany and third-party accounts are identical. What techniques
might help this company better manage its affairs?
ANSWER . Several techniques that might help this company better manage its affairs are as follows:
a) Define and analyze the different available payment channels.
b) Select the most efficient method (which can vary by country and by customer).
CHAPTER 19: CURRENT ASSET MANAGEMENT AND SHORT-TERM FINANCING 265
c) Give specific instructions regarding payment procedures to the firm's customers and banks.
d) Use multilateral netting.
e) Determine the currency of invoice and payment by reference to what is available and what is needed for the
system as a whole.
f) Use treasury workstations to keep track of liquidity world wide.
2. A major U.S. conglomerate operates eight large, independent subsidiaries in France that regularly trade with each
other on an arm's length basis. Some of the units are relatively mature and are net generators of cash; others are
growing rapidly and need cash. In addition, these units trade with a number of other units located in other
countries. They all have dealings with third parties in other countries as well. A recent audit revealed that these
units maintained eight separate accounts at the same bank. What potential areas of improvement are there in this
company's cash management?
ANSWER . There are several potential areas of improvement in this company's cash management.
a) Reducing the number of banks with which it maintains relations. By centralizing relations it is likely to be a
more valuable customer to the remaining banks and can get better service at a lower cost.
b) Cash pooling will enable it to reduce the level of idle cash and raise the return on its cash resources.
c) Multilateral netting will reduce interest and foreign exchange costs by reducing the number the cross-border
3. SmithKline Beckman, the health-care products multinational (now part of GlaxoSmithKline, has 105 affiliates
worldwide. There is a great deal of intercompany sales, dividend flows, and fee and royalty payments. Each unit
makes its intercompany credit, payments, and hedging decisions independently. What advantages might SKB
realize from centralizing international cash management and foreign exchange management?
ANSWER . SKB identified six major benefits from centralizing international cash management and foreign exchange
a) Systems expertise centralized at headquarters. This eliminated redundant offshore systems, personnel, and
facilities, while increasing the level of expertise at which these functions are performed.
b) Speedy communications and processing. By transmitting data to headquarters electronically from around
the world, SKB can respond immediately to changes in affiliate circumstances.
c) Better overall picture of where the affiliates stand. Management now has a more complete view of the
affiliates' current assets and liabilities and cash flows. This enables the company to better manage these
d) Help local managers better manage their financial positions . The system imposes a discipline on affiliate
management which is viewed as a major benefit. Under netting, for example, intercompany accounts are
cleared each month, and local managers are more conscious of their inflows and outflows. If an affiliate is late
in sending a payment through the netting system, its managers know they will get a call from headquarters.
e) Lower bank costs. Netting saves SKB about $300,000 annually in bank foreign exchange transactions costs
and bank transfer charges. Centralizing the netting and foreign exchange functions doubled the volume of FX
transactions done through headquarters and resulted in more favorable FX quotes for SKB. This has provided
SKB with better service, better rates, and more advice from its banks.
266 INSTRUCTORS MANUAL: FOUNDATIONS OF MULTINATIONAL FINANCIAL MANAGEMENT, 4TH ED.
f) Reduced interest expenses. By shifting funds from cash rich to cash poor units SKB can cut interest
4. Pfizer, the pharmaceutical company, generates approximately 52% of its sales overseas. A consulting study of
treasury management revealed that the international division had its own treasury group that reported to the
president of the international division. Both the domestic and the international treasury groups managed sizable
cash portfolios. Moreover, Pfizer Inc. was significantly increasing its issues of U.S. commercial paper, and Pfizer
International had cash surpluses. Intercompany sales were made on an arm's length basis, with no coordination
of payments or credit terms. Each foreign unit would report monthly on what its bank balances were. All banking
relations were managed locally. What profitable opportunities has Pfizer overlooked?
ANSWER . By centralizing cash management and taking advantage of the multinational financial system (which is the
subject of the next chapter), Pfizer can achieve the following objectives:
a) Lower the amount of cash required worldwide through cash pooling, thereby cutting interest expenses. For
example, Pfizer Inc. could reduce the amount of commercial paper it was issuing by tapping into the surplus
cash of Pfizer International.
b) Further reduce surplus cash and increase the interest earned on cash investment by getting up-to-date
information on affiliate cash positions.
c) Use multilateral netting to reduce foreign exchange transactions costs and bank transfer charges.
d) Reduce the number of banks dealt with and their charges.
e) Increase the level of expertise at which these functions are performed; eliminate redundant systems, personnel,
f) Lower taxes by adjusting transfer transfers on intercompany sales and purchases. See Chapter 20.
5. A major food and beverage manufacturer with three major divisions, 150 countries of operation, and international
revenues accounting for 15% of total revenues of $6 billion conducted a treasury audit. It gathered data in the
following areas: (a) local reports put out by the subsidiaries; (b) cross-border reports prepared by regional
headquarters; (c) the system's organization; (d) transmission of data between subsidiaries, regional headquarters,
and parent headquarters; (e) possible computerization of local reporting systems; (f) local-bank-balance reports;
and (g) the accuracy of cash forecasts. What information should the company be looking for in each of these areas
ANSWER . In order to audit the international cash reporting function, here is what the firm needs to examine in each
a) Gather local reports. Most good reporting systems will track data in four areas: credit and collection (total
sums collected, customer credit terms, ratings and histories, aging of receivables, bad-debt expense, days' sales
outstanding); liquidity and bank account management (bank balances, consolidated balances, debt and
investment positions, daily cash position, and weekly or monthly cash forecasts); bank relations (bank
activity, account analysis data, and compensation); and payables (actual disbursements, cash disbursements
outstanding and aging of disbursements).
b) Look at cross-border reports. Is the information detailed and timely enough to permit key decisions to be
made properly? Common barriers that obstruct good sub-to-parent reporting include language difficulties,
local resistance to HQ authority, technical difficulties, and government rules.
CHAPTER 19: CURRENT ASSET MANAGEMENT AND SHORT-TERM FINANCING 267
c) Outline the system's organization. Is the distribution of data centrally controlled? Who is responsible for
what decisions? Are decisions being made high enough in the organization to ensure that all relevant factors
are being considered? Is it low enough in the organization to ensure that relevant information is being utilized?
d) Evaluate how the data are delivered. Is reporting manual or automated? Are telephone, telex, and
telecommunications lines adequate? can local communications be used more effectively to speed up
information flows without boosting costs significantly?
e) Explore computerization options. Options include timesharing services, mainframe systems, stand-alone
micros, and integrated systems in which two or more computers are linked together. Management should
compare the hardware, software, staff, and maintenance costs or computerization against expected savings.
Savings should include lower administrative costs and managerial time, speedier response to a range of cash
management problems and opportunities, and improved decisionmaking.
f) Review local bank balance reports. Do reports arrive too late in the day or are inaccurate, resulting in idle
balances or overdrawn accounts? Is this because high-quality reporting services are not available in that
country? Or is it because of bank resistance or lax corporate habits that can be overcome? Are subsidiaries
taking advantage of special services that can lead to improved reporting? These include multibank reporting,
automatic reconciliation and concentration accounts, and--most important of all--electronic reporting.
g) Check the accuracy of cash forecasts . Are funds lying idle in low- or non-interest-bearing accounts? Does
the treasury regularly under- or overshoot its target balances or the subsidiary relies too much on overdrafts?
Are actual cash balances, funds flows and float times consistently different from the original forecasts? Is
there a regular review and correction of discrepancies between actuals and forecasts?
6. Twenty different divisions of Union Carbide sell to thousands of customers in more than 50 countries throughout
the world. The proceeds are received in the form of drafts, checks, and letters of credit. Controlling the flow of
funds from each transaction is an extremely complex task. Union Carbide wants to reduce the collection float to
improve its cash flow. What are some techniques that might help to achieve this objective?
ANSWER . To reduce days sales outstanding (DSO) so as to reduce collection float, Union Carbide must identify
where the delays are. Are the delays caused by customers, foreign banks, or the exporter itself? What are the relative
magnitudes of each type of delay and can simple changes eliminate significant portions of float? As most firms have
found, Union Carbide will probably be able to reduce its collection float by modifying the way it prepares and mails
out documents, changing customer payment methods, and concentrating its collection activity in far fewer banks.
Here are some techniques that can help to reduce float:
a) Date drafts when goods are shipped, not several days later.
b) Have customers remit funds by wire transfer instead of by check.
c) Have foreign banks remit funds by SWIFT or cable transfer rather than by check.
d) Cut the banking chain to a minimum so that an international money transfer passes through as few banks as
possible between the time it is initiated by the customer and the time the payment instruction arrives at the
U.S. collecting bank.
e) Have U.S. collecting banks speed up the process of crediting Union Carbide with good funds after receiving
payment instructions or receiving check deposits.
f) Pay close attention to high value transfers and make special arrangements where necessary to expedite these
268 INSTRUCTORS MANUAL: FOUNDATIONS OF MULTINATIONAL FINANCIAL MANAGEMENT, 4TH ED.
g) Convert the customer's payment into dollars in the importer's country if it is cheaper and/or quicker to do so
h) Maintain accounts in the currencies of customers where doing so will expedite clearing of payments.
7. RJR Nabisco, the tobacco and consumer products company, sells in more than 160 countries around the world.
RJR collects, disburses, or invests more than $50 million each day in up to 80 different currencies. Much of the
fund flows involve interaffiliate flows. In the mid-1980s, RJR's Corporate Treasury group discovered that
combined borrowing of all RJR units totaled approximately $120 million to $130 million on a daily basis.
Simultaneously, short-term investments entered into by RJR units ranged from $90 million to $100 million daily.
Moreover, there was no central management of the fund flows. What are your recommendations to improve RJR's
international cash management? Where and how might savings be achieved?
ANSWER . RJR dealt with these problems by creating a centralized approach to international treasury management.
by balancing cash among its operating companies on a daily basis, RJR is able to prevent some of the companies from
investing surplus cash while other companies are borrowing at a higher interest rate. Centralization also ensures that
accumulated excess funds are invested quickly and at the best available yield.
The first step in centralizing RJR's treasury operation was development of a computerized system for continuous flow
of pertinent financial information from all locations to RJR's headquarters in Winston-Salem, N.C. To gain a
quick-response capability while retaining hands-on centralized management, RJR next established regional corporate
treasury centers in London and Hong Kong. Despite these regional centers, RJR still could not fully direct its total
worldwide cash flows. Pockets of excess cash were still being held by some operating units, while at the same time
other units were taking short-term loans from local banks. So RJR went further. In 1982 it formed a company-owned
financial operation, FINCO (short for "Finance Company"), based in Geneva, Switzerland. FINCO acts as a
clearinghouse for RJR's overseas treasury operations.
Through FINCO, the cash holdings of most RJR overseas businesses are centralized on a daily basis. As a result, the
company has been able to substantially reduce the amount of foreign currency transactions costs paid to banks. For
example, one RJR subsidiary may accumulate an excess amount of Deutsche marks, but need lira to pay expenses
incurred in Italy. Often the lira can be supplied by another RJR subsidiary through FINCO without the corporation
incurring FX fees for converting the marks to lira. FINCO operates a cash pool and conducts multilateral netting.
Surplus funds generated by RJR's overseas operations are deposited with FINCO, which, in turn, lends to other RJR
units requiring funds. As a result, RJR has been able to reduce its short-term borrowing fro m as much as about $130
million on any given day to as little as around $20 million. When excess funds are insufficient to meet total borrowing
needs, FINCO can borrow from third-party banks. Usually it can borrow under terms more advantageous than
individual operating units could secure from their local banks. FINCO invests excess funds, typically at more attractive
rates than those available to the individual units with surpluses.
8. Newport Circuits is trying to decide whether to shift production overseas of its relatively expensive integrated
circuits (they average around $11 each). Offshore assembly would save about 11.1 cents per chip in labor costs.
But by producing offshore, it would take about five weeks to get the parts to customers, in contrast to one week
with domestic manufacturing. Thus, offshore production would force Newport to carry another four weeks of
inventory. In addition, offshore production would entail combined shipping and customs duty costs of 3.2¢.
Suppose Newport's cost of funds is 15%. Will it save money by shifting production offshore?
ANSWER . Ignoring any problems associated with distance, the net benefit to Newport of shifting production abroad
Labor cost savings - (shipping + customs duty + cost of money tied up in inventory)
CHAPTER 19: CURRENT ASSET MANAGEMENT AND SHORT-TERM FINANCING 269
The key here is to estimate the final term. By producing abroad, Newport will be forced to carry another four weeks
of inventory. At an annual cost of funds equal to 15% and an average cost per chip of $11, the added inventory-related
interest expense due to overseas production equals:
Added interest opportunit y added time x cost/
expense cost of funds in transit part
= .15 x (4/52) x $11 = $0.127
Returning to the equation above, the net benefit to Newport of offshore production equals -4.8¢ [11.1¢ - (3.2¢ +
12.7¢)]. Hence, it is not worthwhile to shift production abroad. The higher inventory carrying cost alone will more than
offset the labor cost savings.
9. Tiger Car Corp., a leading Japanese automaker, is considering a proposal to locate a factory abroad in Tennessee.
Although labor costs would rise by ¥33,000 per car, the time in transit for the cars (to be sold in the United States)
would be reduced by 65 days. Tigers sell for ¥825,000, and TCC's cost of funds is 12.5%. Should TCC locate the
plant in Tennessee?
ANSWER. Based on the data provided in the question, the net benefit to Tiger Car of shifting production to Tennessee
equals the reduction in its inventory carrying costs less its higher labor costs. The per car inventory carrying cost
savings, which come from the lower interest expenses, equal
Interest opportunity reduced time cost/
= x x
savings cost of funds in transit car
= .12.5% x 65/365 x ¥825,000 = ¥18,365
Since Tiger's costs will actually rise by ¥33,000 - ¥18,365 = ¥14,635, it should not shift production to Tennessee.
10. Apex Supplies borrows FF 1 million at 12%, payable in one year. If Apex is required to maintain a compensating
balance of 20%, what is the effective percentage cost of its loan (in FF)?
ANSWER . The effective interest rate is defined as (annual interest paid)/(funds received). Since Apex Supplies
receives only FF 800,000 net of the compensating balance requirement, this figure is FF 120,000/FF 800,000 = 15%.
11. The Olivera Corp., a manufacturer of olive oil products, needs to acquire Lit 100 million in funds today to expand
a pimento-stuffing facility. Banca di Roma has offered them a choice of an 11% loan payable at maturity or a 10%
loan on a discount basis. Which loan should Olivera choose?
ANSWER . The effective interest rate on the first loan just equals its stated rate of 11%. By contrast, the effective
interest rate on the loan priced on a discount basis is Lit 10 million/Lit 90 million = 11.11%. Hence, the 11% loan is
12. To finance production of its new F-16 bubble gum, Hong Kong-based Top Gum Co. has been offered a one-year
loan of HK$1.25 million at 9% payable at maturity with a 10% compensating balance.
a. What is the effective interest rate on this loan (in HK$)?
270 INSTRUCTORS MANUAL: FOUNDATIONS OF MULTINATIONAL FINANCIAL MANAGEMENT, 4TH ED.
ANSWER . The effective interest rate on this loan is HK$1.25 x .09/HK$1.25 x .9 = 10%, where dollar figures are
expressed in millions.
b. If the compensating balance requirement is 20%, what will be the effective interest rate?
ANSWER . The effective interest rate now becomes HK$1.25 x .09/HK$1.25 x .8 = 11.25%.
c. If the compensating balance is 10%, but the loan is on a discount basis, what will be the effective interest rate?
ANSWER . The effective interest rate now equals HK$1.25 x .09/(HK$1.25 x .9 - HK$1.25 x .09) = 11.11%.
d. If the company requires HK$1.25 million, how much must it borrow in part c to receive this amount?
ANSWER . Let L be the size of Top Gum's loan. The amount it winds up with is .9L - .09L = .81L. Hence, the amount
it needs to borrow to receive HK$1.25 million can be found by solving .81L = HK$1,250,000, or L = HK$1,543,210.
CHAPTER 19: CURRENT ASSET MANAGEMENT AND SHORT-TERM FINANCING 271
NOTES ON INTERNATIONAL CASH MANAGEMENT
a) Trend toward greater centralization
i. reduce total amount of cash holdings
ii. better perspective of corporate activities, problems, and opportunities
iii. corporate optimization, rather than affiliate optimization
iv. greater expertise in cash and portfolio management
2. Collection and disbursement
a) Accelerating collections and delaying disbursements
b) More valuable in international environment because of material delays in sending and receiving funds across
c) Corporate management is increasingly participating in monitoring affiliate collection performance
3. Netting intercompany payments
a) Bilateral netting
A <===========> B
Net amount - A pays B $1 million.
$1 million $1 million
b) Multilateral netting
Total transfers net out to 0.
c) Advantages of netting
i. minimize funds transfer commissions
ii. minimize foreign exchange costs
iii. minimize float on intercompany remittances
iv. improve cash flow forecasting
v. develop an integrated cash and exposure management system
vi. standardize intercompany settlement procedures
d) Information requirements
i. amounts and currencies of flows
ii. origins and destinations of flows
iii. timing of these flows
iv. unit costs of sending funds between any two points
272 INSTRUCTORS MANUAL: FOUNDATIONS OF MULTINATIONAL FINANCIAL MANAGEMENT, 4TH ED.
e) Corporate practice
i. used by many firms, especially those which manufacture low-weight, high-value products
ii. more firms integrating netting with FAS No. 52 exposure management
iii. can facilitate leading and lagging
4. Investing excess funds
a) National money markets
b) Eurodollar market
c) Corporate practice - three philosophies
i. remit all excess cash to the parent, which uses it to retire debt
ii. centralize cash management at corporate headquarters and invest excess cash in dollar-denominated
iii. maximize returns worldwide
5. Cash planning and budgeting
a) Information requirements
i. cash forecasts of position and flow, by affiliate, currency, and date
b) Multinational cash mobilization
i. optimize the use of funds by tracking cash positions
c) Reinvoicing centers
i concentrates cross-border trade flows in one entity
ii. centralize foreign exchange exposure
iii. concentrates cash flows and bank relations
iv. liquidity management - leads and lags
1. Reinvoicing centers
2. Factoring companies
3. Finance companies
4. Netting centers
1. Shifting liquidity from surplus to deficit affiliates.
2. Centralized foreign exchange risk management.
3. Reduce taxes by transfer price adjustments.
4. Assure consistent pricing to customers placing orders with more than one unit.
5. Netting intercompany transfers.
6. Take advantage of economies of scale in financing and investing.
7. Concentrate trading expertise.
8. Concentrate investment expertise.
9. Reduce FX trading costs by dealing in larger volumes.
10. Centralizing control over finance functions.
CHAPTER 19: CURRENT ASSET MANAGEMENT AND SHORT-TERM FINANCING 273
POTENTIAL SOURCES OF SAVINGS IN INTERNATIONAL CASH
1. Check invoice dates and payment terms.
a) Do invoice dates match shipment dates?
b) Are the terms of payment and discounts no more generous than competition requires?
2. Use concentration banks.
a) Are there significant delays in cross-border collections?
b) Are there significant costs in clearing individual checks?
3. Negotiate with banks.
a) What are the banks value-dating practices
b) How easily can your banks clear checks drawn on customer banks or otherwise arrange for transfer of funds
from customer banks?
1. Pay by check.
a) How long does it take for your checks to clear?
b) Who gets to keep the benefit of float during the interim?
c) What effect will this have on supplier goodwill?
2. Take discounts for prompt payment.
a) What are the credit terms?
b) What is the effective annualized interest rate of not taking the discount?
3. Check ways to net and consolidate payments.
a) What is the volume of interaffiliate transactions?
b) What are the costs of these transfers?
Bank Deposits and Loans
1. Invest excess cash
a) What level of compensating balances is required?
b) Are there overdraft facilities? What is the cost?
c) What is the opportunity cost of excess balances?
d) What are day-to-day cash needs?
e) Are large cash transfers being timed precisely?
f) Are funds being pooled?
2. Consolidate bank accounts.
a) How active are accounts?
b) Can banks be compensated directly for services?