CHAPTER 19 MULTINATIONAL CASH MANAGEMENT SUGGESTED ANSWERS AND SOLUTIONS TO END-OF-CHAPTER QUESTIONS AND PROBLEMSQUESTIONS1. Describe the key factors contributing to effective cash management within a firm. Why is the cashmanagement process more difficult in a MNC?Answer: An effective cash management system should be based on a cash budget that projects expectedcash inflows and outflows over some planning horizon. It provides for the systematic receipt anddisbursement of cash. It also provides for funds mobilization, where cash shortages are covered byborrowing at the most favorable rates and surplus funds are invested at the most advantageous rates.Within a MNC the complexity of the cash management process is compounded because the firm doesbusiness in a variety of currencies, and hence the cost of foreign exchange transactions is an additionaldimension to be managed.2. Discuss the pros and cons of a MNC having a centralized cash manager handle all investment andborrowing for all affiliates of the MNC versus each affiliate having a local manager who performs thecash management activities of the affiliate.Answer: Under a centralized cash management system, the cash manager will have a global view of thecash requirements of the MNC. There will be less chance that funds will be mislocated, i.e., denominatedin the wrong currency. Additionally, under a global view, transaction exposure for the MNC can be moreefficiently managed. Moreover, a centralized system readily allows for investing excess cash at the mostadvantageous rates and borrowing to cover cash shortages at the most favorable rates. Under a decentralized system, the local cash manager is given more responsibility for managing thecash needs of the affiliate than under a centralized system. Consequently, the local cash managementposition serves as good training for higher level positions within the affiliate or MNC. Also, under adecentralized system, local bank relationships are better developed since the affiliate conducts more of itscash management functions at the local level. This may prove important if funds need to be borrowedlocally. But overall, the benefits of a centralized cash management system tend to outweigh itsdisadvantages.
PROBLEMS1. Assume that interaffiliate cash flows are uncorrelated with one another. Calculate the standarddeviation of the portfolio of cash held by the centralized depository for the following affiliate members: Expected Standard Affiliate Transactions Deviation _______________________________________________ U.S. $100,000 $40,000 Canada $150,000 $60,000 Mexico $175,000 $30,000 Chile $200,000 $70,000Solution: Portfolio standard deviation = [($40,000)2 + ($60,000)2 + ($30,000)2 + ($70,000)2] =$104,881.
MINI CASE 1: EFFICIENT FUNDS FLOW AT EASTERN TRADING COMPANYThe Eastern Trading Company of Singapore purchases spices in bulk from around the world, packagesthem into consumer-size quantities, and sells them through sales affiliates in Hong Kong, the UnitedKingdom, and the United States. For a recent month, the following payments matrix of interaffiliate cashflows, stated in Singapore dollars, was forecasted. Show how Eastern Trading can use multilateral nettingto minimize the foreign exchange transactions necessary to settle interaffiliate payments. If foreignexchange transactions cost the company .5 percent, what savings result from netting? Eastern Trading Company Payments Matrix (S$000) Disbursements Receipts Singapore Hong Kong U.K. U.S. Total Receipts Singapore -- 40 75 55 170 Hong Kong 8 -- -- 22 30 U.K. 15 -- -- 17 32 U.S. 11 25 9 -- 45 Total disbursements 34 65 84 94 277
Suggested Solution to Mini Case 1: Efficient Funds Flow at Eastern Trading Company S$8 Singapore S$40 Hong Kong S$11 S$15 S$75 S$25 S$22 S$55 S$9 United United S$17 States KingdomBilateral Netting Singapore S$32 Hong Kong S$60 S$3 S$44 United United S$8 States Kingdom
Multilateral Netting Singapore S$35 Hong Kong S$52 S$49 United United Kingdom States Without netting, S$277,000 of interaffiliate foreign exchange transactions occur among the four affiliates of Eastern Trading. With multilateral netting, interaffiliate foreign exchange transactions are reduced to S$136,000, or by S$141,000. The savings are .005 x S$141,000 = S$705 for the planning period.MINI CASE 2: EASTERN TRADING COMPANY’S NEW M.B.A.The Eastern Trading Company of Singapore presently follows a decentralized system of cashmanagement where it and its affiliates each maintain their own transaction and precautionary cashbalances. Eastern Trading believes that it and its affiliates’ cash needs are normally distributed andindependent from one another. It is corporate policy to maintain two and one-half standard deviations ofcash as precautionary holdings. At this level of safety there is a 99.37 percent chance that each affiliatewill have enough cash holdings to cover transactions.
A new MBA hired by the company claims that the investment in precautionary cash balances isneedlessly large and can be reduced substantially if the firm converts to a centralized cash managementsystem. Use the projected information for the current month, which is presented below, to determine theamount of cash Eastern Trading needs to hold in precautionary balances under its current decentralizedsystem and the level of precautionary cash it would need to hold under a centralized system. Was the newMBA a good hire? Affiliate Expected One Standard Transactions Deviation Singapore S$125,000 S$40,000 Hong Kong 60,000 25,000 United Kingdom 95,000 40,000 United States 70,000 35,000Suggested Solution to Mini Case 2: Eastern Trading Company’s New M.B.A. Affiliate Expected One Standard Expected Needs plus Transactions (a) Deviation Precautionary (a + (b) 2.5b) Singapore S$125,000 S$40,000 S$225,000 Hong Kong 60,000 25,000 122,500 United Kingdom 95,000 40,000 195,000 United States 70,000 35,000 157,500 S$700,000 Total S$350,000
Eastern Trading is holding S$350,000 to cover expected transactions and S$350,000 as precautionarybalances among the four affiliates. In total, it is holding S$700,000 under its decentralized cashmanagement system. If Eastern Trading views its cash needs from a portfolio perspective under a centralized cashmanagement system, one portfolio standard deviation of cash would be:Portfolio = (S $40,000 ) 2 + (S $25,000 ) 2 + (S $40,000 ) 2 + (S $35,000 ) 2Std . Dev . = S $71,063Hence, under a centralized system, Eastern Trading would continue to need S$350,000 to cover expectedtransactions, but precautionary cash balances could be reduced to $177,658 (= 2.5 x S$71,063). Thus, theinvestment in precautionary cash can be reduced by S$172,342 (= S$350,000 – 177,658). The new MBAwas a good hire.