Question

Part 4: International Financial Management Citrus, Inc. is a medium-sized producer of citrus juice drinks in Florida. Until now, the company has confined its operations and sales to the United States, but its CEO, Heidi Sims, wants to expand into Europe. The first step would be to set up sales subsidiaries in Spain and Sweden, then to set up a production plant in Spain, and, finally, to distribute the product throughout the European Union. The firm’s financial manager, George Benson, is enthusiastic about the plan, but he is worried about the implications of the foreign expansion on the firm’s financial management process. He has asked you, the firm’s most recently hired financial analyst, to develop a 1-hour tutorial package that explains the basics of multinational financial management. The tutorial will be presented at the next board of director’s meeting. To get you started, Benson has supplied you with the following list of questions. A. What is a multinational corporation? Why do firms expand into other countries? B. Discuss at least six major factors which distinguish multinational financial management from financial management as practiced by a purely domestic firm. (Please consider doing additional research on this question and document your findings). C. Discuss exchange rate risk as they relate to multinational corporations. D. Describe the current International Monetary System. How does the current system differ from the system that was in place prior to August 1971? (Please consider doing additional research on this question and document your findings). E. What is the difference between spot rates and forward rates? When is the forward rate at a premium to the spot rate? At a discount? (Please consider doing additional research on this question and document your findings). F. From a managerial point of view, discuss how your responses above will help Citrus, Inc. as they plan to expand overseas.

Answer 1

Part A

Multinational corporations are big firms that have their head office or are incorporated in one country but also have their operations going on in various other countries which are effectively controlled by the parent company. A few examples are Coca Cola, Apple, etc.

Companies may consider expanding into other countries for various reasons like to achieve economies of scale, culture diversification, availability of better and cheaper resources, currency exchange benefit, other operational perks like tax concessions and trade deals.

Part B

Factors that differentiate a multinational corporation financial management from domestic financial management are as follows:
1) Political risk - political stability of the target country is a factor that needs to be thoroughly assessed by a company before expanding as government intervention plays a big role in making the business environment favorable for the companies.
2) Cultural differences - each country has a different country and this sometimes poses a big challenge for the company. This further impacts the type of marketing strategies and also the sort of product and services that the company may choose.
3) Economic and Legal structures - legalities and customs vary in different countries and different bodies are present carrying out different roles and the company should prepare itself in order to cope with this functionality.
4) Currency denominations: more than one currency type is generally used while carrying out business activities overseas and the exchange rates can also prove inconvenient at times.
5) Government roles - the effectiveness and efficiency of the government in power, directly and indirectly, impact the economy and hence, the companies. The level of red-tapism, corruption, favoritism can both encourage and demotivate an MCN to enter in the market.
6) Languages - clothes and words should change as per the environment. Dealing in the overseas markets requires the company to be thorough with the local language to be more productive even if it costs a few pennies more to the company.

PART C

Exchange rate risk, also known as currency risk is the risk of fluctuations in the value of currencies involved in the trade.
If the company is the exporter then it becomes favorable for the company if the domestic currency weakens relative to the foreign currency.
And for an importing company, it becomes favorable if the domestic currency strengthens.

Part D

The current International Monetary system follows the fiat system.
Fiat system is in which a legal tender whose value is backed by the government that issues it is used to trade. The system that used to be followed in 1971 was the commodity or gold standard.
In the gold standard system, the monetary system was based on the value of gold and in the fiat system, the value of a currency is not backed by any commodity and is allowed to fluctuate and change as per the economic conditions in comparison to other economic currencies.

Part E

Spot rates are the rates used to get into a contract taking place immediately whereas forward rates are the rates used for contracts scheduled to happen in the future.

Premium and discount of a forward rate and spot rate are determined by the interest rates in the foreign and domestic country.
Forward rate = spot rate * (interest in foreign country/ interest in the domestic country.)
So, if the interest rate in foreign currency is higher then the forward rate will be at a premium to the spot rate.

Part F

Citrus, Inc. must be fully aware and equipped with the factors related to the European market and understand how it is different than the US market. Along with understanding the financial implications, the company must also take into account the currency factor and the economic parameters that can have impacts on the exchange rate.