Kelompok 3 kelas A:

Fatona Hayati Nafsiah (C1B018003)

Wening Dwi Fatonah (C1B018078)

Yahya Riantas (C1B018051)

Chapter Review International Cash Management

A subsidiary is a company that belongs to another company, which is usually referred to as

Subsidiaries become very important when discussing a reverse triangle mortgage. The
management of working capital has a direct influence on the amount and timing of cash flow:

• inventory management , refers to the process of ordering, storing, using, and selling a
company's inventory. This includes the management of raw materials, components, and
finished products, as well as warehousing and processing of such items.

• accounts receivable management , Accounts receivable management is all about ensuring

• cash management , Cash management is the process of collecting and managing cash
flows. Cash management can be important for both individuals and companies. In business, it
is a key component of a company's financial stability.

• liquidity management , A liquidity management strategy means your business has a plan
for meeting its short-term and immediate cash obligations without experiencing significant
losses. It means your company is managing its assets, including cash to meet all liabilities,
cover all expenses and maintain financial stability.
¤ Subsidiary Expenses

International purchases of raw materials or supplies are more likely to be difficult to manage
because of exchange rate fluctuations, quotas, etc. If the sales volume is highly volatile,
larger cash balances may need to be maintained in order to cover unexpected inventory
demands.
¤ Subsidiary Revenue

International sales are more likely to be volatile because of exchange rate fluctuations,
business cycles, etc. Looser credit standards may increase sales (accounts receivable), though
often at the expense of slower cash inflows.
 ¤ Subsidiary Dividend Payments

Forecasting cash flows will be easier if the dividend payments and fees (royalties and
overhead charges) to be sent to the parent are known in advance and denominated in the
subsidiary’s currency.

¤ Subsidiary Liquidity Management

After accounting for all cash outflows and inflows, the subsidiary must either invest its
excess cash or borrow to cover its cash deficiencies. If the subsidiary has access to lines of
credit and overdraft facilities, it may maintain adequate liquidity without substantial cash
balances.
Centralized Cash Management

Process by which an affiliated group of businesses makes all or most cash management
decisions from one location, such as a headquarters or designated subsidiary, that results in
individual affiliates having little autonomy in making decisions concerning how cash is
managed. International cash management can be segmented into two functions:

• optimizing cash flow movements , is to offer forecast-based assistance in making optimal

• investing excess cash , Excess cash typically refers to a surplus of cash resulting from
company operations or the proceeds of the sale of a major asset—in other words, cash that is
the product of normal business activity that is being held until it is used to pay down debt or
reinvested in a long-term investment.

The centralized cash management division of an MNC cannot always accurately forecast the
events that may affect parent- subsidiary or intersubsidiary cash flows.
Techniques to Optimize Cash Flows

Accelerating Cash Inflows

• The more quickly the cash inflows are received, the more quickly they can be invested or
used for other purposes.

• Common methods include the establishment of lockboxes around the world (to reduce mail
float) and preauthorized payments (direct charging of a customer’s bank account).

Minimizing Currency Conversion Costs

• Netting reduces administrative and transaction costs through the accounting of all
transactions that occur over a period to determine one net payment.
• A bilateral netting system involves transactions between two units, while a multilateral
netting system usually involves more complex interchanges.

Managing Blocked Funds

• A government may require that funds remain within the country in order to create jobs and
reduce unemployment.

• The MNC should then reinvest the excess funds in the host country, adjust the transfer
pricing policy (such that higher fees have to be paid to the parent), borrow locally rather than
from the parent, etc.

Managing Intersubsidiary Cash Transfers

• A subsidiary with excess funds can provide financing by paying for its supplies earlier than
is necessary. This technique is called leading.

• Alternatively, a subsidiary in need of funds can be allowed to lag its payments. This
technique is called lagging.
Complications in optimizing cash flow

Most of the complications encountered in optimizing cash flow can be classified into three
categories:

• Company-related characteristics

In some cases, optimizing cash flow can be complicated due to the characteristics of the
MNC. If one subsidiary delays payment to another subsidiary for inventory received, the
other subsidiary may be forced to borrow until payment arrives. A centralized approach that
monitors all payments between subsidiaries should minimize this problem.

• Government restrictions

The existence of government restrictions can disrupt the cash flow optimization policy. Some
governments prohibit the use of system netting, as carlier notes. In addition, some countries
periodically prevent cash from leaving their country, thereby preventing net payments from
being made. This issue can arise even for MNCS that are not experiencing enterprise-related
issues. Countries in Latin America usually impose restrictions that affect MNC cash flows.

• Characteristics of the banking system

The ability of banks to facilitate cash transfers for MNCs varies between countries. Banks in
the United States are advanced in this area, but banks in some other countries do not offer the
service. MNCs prefer some form of controlled account (zero balance account), where: Excess
funds can be used to make payments but earn interest until used. In addition, some MNCs
may benefit from using a lockbox. Such services are not available in some countries. In
addition, banks may not adequately update MNC bank account information or provide
detailed breakdown of banking service fees. Without full use of banking information and
resources, the effectiveness of international cash management is limited. In addition, an MNC
with subsidiaries in, say, eight different countries will typically deal with eight different
banking systems. Much progress has been made in the foreign banking system in recent
years. As time goes on and a more uniform global banking system emerges, such problems
can be overcome

Investing Excess Cash

How to Invest Excess Cash

International money markets have evolved to accommodate corporate investments that have
excess cash. MNCs may use international financial markets in an attempt to earn higher
returns than they can achieve domestically.

Eurocurrency deposits are one of the most commonly used international money market
instruments. Many MNCs set large deposits in multiple currencies in the Eurocurrency
market, with Eurodollar deposits being the most popular. The dollar volume of Eurodollar
deposits has more than doubled since 1980. Eurodollar deposits typically offer MNCs slightly
higher yields than bank deposits in the United States. Although Eurodollar deposits still
dominate the market, the relative importance of nondollar currencies has increased over time.

In addition to using the Eurocurrency market, MNCs can also buy foreign securities and
securities. Better telecommunications systems have increased access to these securities in
foreign markets and have allowed a greater degree of integration between financial markets
in different countries.

Centralized Cash Management

The MNC's short-term investment policy can maintain separate investments for all
subsidiaries or use a centralized approach. Remember that the function of optimizing cash
flow can be improved with a centralized approach because all the cash positions of
subsidiaries can be monitored simultaneously. With regard to the investment function,
centralization allows for a more efficient use of funds and the possibility of higher returns.
Here the term centralized means the excess cash from each subsidiary is pooled until it is
needed by a particular subsidiary.

• Centralization When Subsidiaries Use the Same Currency.

To understand the advantages of a centralized system, consider that the rates paid for short-
term investments such as bank deposits are often higher for larger amounts. Thus, if two
subsidiaries have an excess of $50,000 in cash each for one month, their respective bank
deposit rates may be lower than the rates they could earn if they pooled their funds into a
single $100,000 bank deposit. In this way, the centralized (pooling) approach results in a
higher rate of return on excess cash.
A centralized approach can also facilitate the transfer of funds from overfunded subsidies to
those in need.

• Multi-Currency Centralized Cash Management.

Centralized cash management is more complicated when the MNC uses multiple currencies.
All excess funds can be pooled and converted to a single currency for investment purposes.
However, the benefits of pooling can be offset by the transaction costs incurred when
converting to a single currency.

Centralized cash management can still be valuable. Short-term cash available between
subsidiaries can be pooled together so that there is a separate pool for each currency. Then
the excess cash in a certain currency can still be used to cover the shortage of other
subsidiaries in that currency. In this way, funds can be transferred from one subsidiary to
another without incurring transaction fees that banks charge for currency exchange. This
strategy is very possible when all subsidy funds are stored in a branch of one bank so that
funds can be easily transferred between subsidiaries.

• Impact of Technology on Centralized Cash Management.

International cash management requires timely information across subsidiaries about each
subsidiary's cash position in each currency, along with interest rates in formations about each
currency. A centralized cash management system requires a continuous flow of information
about currency positions so as to determine whether one subsidiary's cash shortfall can be
offset by another subsidiary's cash surplus in that currency. Given the huge improvements in
online technology in recent years, all MNCs can easily and efficiently establish multinational
communication networks among their subsidiaries to ensure that information on cash position
is kept up to date.

Determining Effective Yield

Companies usually consider investing in deposits in a currency with a high interest rate and
then converting the funds back into dollars when the deposit matures. This strategy is not
necessarily feasible because the currency that denominates the deposit may depreciate over
the life of the deposit. If so, the gains from the higher interest rate may be more than offset by
the depreciation of the currency representing the deposit.

As a result, it is the effective yield on deposits, not the interest rate, that is most important to
cash managers. The effective yield on bank deposits takes into account the interest rate and
the rate of appreciation (or depreciation) of the currency in which the deposit is denominated
and can therefore be very different from the quoted interest rate on deposits denominated in
foreign currencies.

The calculation of the effective return on foreign deposits was previously carried out in a
logical manner.
The effective yield of a foreign deposit is represented by r, if is the quoted interest rate, and ef
is the percentage change (from day of deposit to day of withdrawal) in the value of the
currency representing the foreign deposit. The term if used in

Interest Rate Parity Implications

Recall that closed interest arbitrage is described as a short-term foreign investment with
simultaneous forward sales of the foreign currency denominated foreign investment. One
might think that a foreign currency with a high interest rate would be an ideal candidate for
closed interest arbitrage. However, such a currency will usually show a forward discount that
reflects the difference between its interest rate and the investor's home interest rate. This
relationship is based on the theory of interest rate parity. Investors cannot lock in higher
returns when attempting covered interest arbitrage if interest rate parity exists.

Using Forward Rate as Forecast

if interest rate parity exists, the forward rate serves as the break-even point for assessing
short-term investment decisions. When investing in foreign currencies (and not covering
foreign currency positions), the effective return will be more than the domestic yield if the
spot rate of the foreign currency after one year is more than the forward rate at the time the
investment was made. On the other hand, foreign investment returns will be lower than
domestic returns if the foreign currency spot rate after one year is lower than the forward rate
at the time the investment was made.

Use of Exchange Rate Forecast

Although MNCs do not know how currency values will change over the investment horizon,
they can use the formula for effective returns given earlier in this chapter and enter their
estimates for the percentage change in foreign exchange rates (ef). Since the interest rate on
foreign currency deposits (if) is known, its effective yield can be forecasted by an estimate of
ef . The projected effective returns on these foreign deposits can then be compared with the
returns when investing in the company's local currency.

Diversification Across Currencies

Since the MNC is unsure how exchange rates will change over time, it may prefer to
diversify its cash among securities denominated in different currencies. Limiting the
percentage of excess cash invested in each currency reduces the MNC's exposure to exchange
rate risk. The extent to which a portfolio of investments in multiple currencies will reduce
risk depends on the correlation of currencies. Ideally, the currencies represented in the
portfolio will show a low or negative correlation with each other. When currencies are likely
to be affected by the same underlying event, their movements tend to be more highly
correlated, and diversification among these types of currencies does not substantially reduce
exposure to exchange rate risk.
Dynamic Hedging

Some MNCs continue to adjust their short-term positions in currencies in response to revised
expectations of future movements of individual currencies. They may engage in dynamic
hedging, which is a strategy of applying hedging when the held currency is expected to
depreciate and removing the hedge when the held currency is expected to appreciate. If the
British pound begins to decline and is expected to depreciate further, the treasurer may sell
the pound forward on the foreign exchange market for a future date at which the value of the
pound is expected to rise. In this way, the treasurer has removed the existing fence. Of
course, if the forward rate at the time of the forward purchase exceeds the prevailing forward
rate at the time of the forward sale, an expense is incurred to offset the hedge.

Impact of International Cash Management on an MNC’s Value

Facilitate consolidation in MNC, so that they can carry out cash management properly so as
to optimize cash flow and invest excess cash in company. Running cash management is very
complex. and can reduce exchange rate fluctuations which can actually affect the value of
cross-border cash transfers. Thus, financial managers must understand the advantages and
disadvantages of investing cash in foreign markets so that they can make international cash
management decisions that maximize the value of the MNC. so they can carry out MNC
activities better and more productively to achieve productivity.

The management of working capital is more complex for MNCs that have foreign
subsidiaries because each subsidiary must have adequate working capital to support its
operations. If a subsidiary experiences adeficiency in inventory, its production may be
delayed. If it is short of cash, it may be unable to purchase supplies or materials. If the parent
of an MNC is aware of the working capital situation at every subsidiary, it may be able to
transfer working capital from one subsidiary to another in order to solve temporary
deficiencies at any subsidiary.