CHAPTER 19 MULTINATIONAL CASH MANAGEMENT

SUGGESTED ANSWERS AND SOLUTIONS TO END-OF-CHAPTER

QUESTIONS AND PROBLEMS

QUESTIONS

1. Describe the key factors contributing to effective cash management within a firm. Why is the cash
management process more difficult in a MNC?

Answer: An effective cash management system should be based on a cash budget that projects expected
cash inflows and outflows over some planning horizon. It provides for the systematic receipt and
disbursement of cash. It also provides for funds mobilization, where cash shortages are covered by
borrowing 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 does
business in a variety of currencies, and hence the cost of foreign exchange transactions is an additional
dimension to be managed.

2. Discuss the pros and cons of a MNC having a centralized cash manager handle all investment and
borrowing for all affiliates of the MNC versus each affiliate having a local manager who performs the
cash management activities of the affiliate.

Answer: Under a centralized cash management system, the cash manager will have a global view of the
cash requirements of the MNC. There will be less chance that funds will be mislocated, i.e., denominated
in the wrong currency. Additionally, under a global view, transaction exposure for the MNC can be more
efficiently managed. Moreover, a centralized system readily allows for investing excess cash at the most
advantageous 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 the
cash needs of the affiliate than under a centralized system. Consequently, the local cash management
position serves as good training for higher level positions within the affiliate or MNC. Also, under a
decentralized system, local bank relationships are better developed since the affiliate conducts more of its
cash management functions at the local level. This may prove important if funds need to be borrowed
locally. But overall, the benefits of a centralized cash management system tend to outweigh its
disadvantages.
PROBLEMS

1. Assume that interaffiliate cash flows are uncorrelated with one another. Calculate the standard
deviation 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 $70,000

Solution: 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 COMPANY

The Eastern Trading Company of Singapore purchases spices in bulk from around the world, packages
them into consumer-size quantities, and sells them through sales affiliates in Hong Kong, the United
Kingdom, and the United States. For a recent month, the following payments matrix of interaffiliate cash
flows, stated in Singapore dollars, was forecasted. Show how Eastern Trading can use multilateral netting
to minimize the foreign exchange transactions necessary to settle interaffiliate payments. If foreign
exchange 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
Kingdom

Bilateral 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 cash
management where it and its affiliates each maintain their own transaction and precautionary cash
balances. Eastern Trading believes that it and its affiliates’ cash needs are normally distributed and
independent from one another. It is corporate policy to maintain two and one-half standard deviations of
cash as precautionary holdings. At this level of safety there is a 99.37 percent chance that each affiliate
will have enough cash holdings to cover transactions.
A new MBA hired by the company claims that the investment in precautionary cash balances is
needlessly large and can be reduced substantially if the firm converts to a centralized cash management
system. Use the projected information for the current month, which is presented below, to determine the
amount of cash Eastern Trading needs to hold in precautionary balances under its current decentralized
system and the level of precautionary cash it would need to hold under a centralized system. Was the new
MBA 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 35,000

Suggested 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 precautionary
balances among the four affiliates. In total, it is holding S$700,000 under its decentralized cash
management system.
If Eastern Trading views its cash needs from a portfolio perspective under a centralized cash
management 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 ) 2

Std . Dev .
= S $71,063

Hence, under a centralized system, Eastern Trading would continue to need S$350,000 to cover expected
transactions, but precautionary cash balances could be reduced to $177,658 (= 2.5 x S$71,063). Thus, the
investment in precautionary cash can be reduced by S$172,342 (= S$350,000 – 177,658). The new MBA
was a good hire.