INTERNATIONAL

FINANCIAL
MANAGEMENT
Fifth Edition
EUN / RESNICK

McGraw-Hill/Irwin Copyright 2009 by The McGraw-Hill Companies, Inc. All rights reserved.

Multinational Cash
Management

19

Chapter Nineteen

Chapter Objective:
This chapter discusses various issues associated
with multinational cash management.
Fifth Edition

19-2

Chapter 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 Practice

19-3

The Management of International Cash

Balances
The

size of cash balances

The currency denomination
Where these cash balances are located

19-4

The Size of Cash Balances

The

optimal size of the firms cash balances

depend upon:

The

cost of keeping too much cash on hand.

i.e.

The

cost of not keeping enough cash on hand.

i.e.

The

19-5

the opportunity costs of holding cash

the trading costs associated with having too little cash

variability of cash flows.

Costs in dollars of holding cash

The Size of Cash Balances

Trading costs increase when the firm
must sell securities to meet cash needs.
Total cost of holding cash
Opportunity
Costs
The investment income
foregone when holding cash.
Trading costs
C*
19-6

Size of cash balance

Choice of Currency
By

maintaining cash balances in a particular

currency, the MNC is essentially speculating (or
hedging?) in that currency.

19-7

Where 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?

19-8

Netting: Bilateral and Multilateral

Multilateral

Is an efficient and cost-effective mechanism for settling

interaffiliate foreign exchange transactions.

Not

19-9

Netting

all countries allow MNCs to net payments

By limiting netting, more unnecessary foreign exchange

transactions flow through the local banking system.

Exposure Netting: an Example

Consider a U.S. MNC with three subsidiaries and the
following foreign exchange transactions ($000s):
$20
$30
$40
$10 $35

$10
$25
$20
$30

19-10

$60

$30 $40

Exposure Netting: an Example

Bilateral Netting would reduce the number of foreign
exchange transactions by half:
$20
$10
$30
$10$25$35

$40
$20

$15 $10

$25
$20
$10
$30

19-11

$60

$30$10$40

Multilateral Netting: an Example

Consider simplifying the bilateral netting with multilateral
netting:
$10

$15$25
$15
$10

$20
$30
$40
$40

$15
$15
$10

$10
19-12

$10

Netting with Central Depository

Some firms use a central depository as a cash pool to facilitate
funds mobilization and reduce the chance of misallocated funds.

$15

$55
Central
depository

$40

19-13

Netting with Central Depository

Consider

the net cash flows of the affiliates with

the rest of the world:

Affiliate

U.S.
Canada
Germany
U.K.
Total
19-14

Net Receipts from

Multilateral
Netting

Net Excess Cash from

Transactions with
Third Parties

Net Flow

$55,000

$20,000

$35,000

($15,000)

($30,000)

$15,000

$75,000

($75,000)

($40,000)

($25,000)

($15,000)
($40,000)

Netting with Central Depository

Net cash flows after multilateral netting and net
payments from external transactions

$35

$15
Central
depository

$75

19-15

$15

Reduction in Precautionary Cash Balances

An

additional benefit of a centralized cash

depository is that the MNCs 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.

19-16

Cash Management Systems in Practice

The 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.
19-17

Exposure Netting Sample Problem

In the following slides, a firm faces the following

exchange rates:
1.00 = $2.00
1.00 = $1.50
SFr 1.00 = $0.90

Beginning with the next slide, try to use multilateral

netting to reduce the number of transactions as much as
possible.
19-18

Exposure Netting
SFr150
$150

5
$1

150
150
19-19

$150

0
0
5
1
r
SF

SFr150

150

5
1

150

0
5
1

$2.00
$0.90
$1.50
150
=
$300
SFr150
=
$135
150
Exposure
Netting SFr1
1
1 = $225
SFr150
$135
$150

$225
150
150
$300
$300
19-20

SFr150
$135

$300
150
0

0
5
15
r
3
$S$1F

5
$1

$150

500
$13

$225
150
$225

50
2
5
$21

Exposure Netting

$225

$135

$150

5
$1
5
3
$1

$75
$300
19-21

5
2
0
$2
9
$

0
$3

50
$1
0

$225
$75

$150

$15
$300
$165

$135

Exposure Netting

0
9
$

5
$21
+$2
510=
$72

$75
19-22

$165
$180 = $165 +$180
$15

+=
51205
$12

$75

$15

End Chapter Nineteen

19-23