1. ~ Finance Function
Anish Bengeri (5)
Anirudh Jindal (22)
Sachin Mittal (35)

2. Agenda
• The Finance Function
• Capital Structure
• Global Capital Markets
• Offshore Financing and Offshore Financial Centers
• Capital Budgeting in Global Context
• Internal Sources of Funds
• Foreign Exchange Risk Management
• Taxation of Foreign Source Income

3. Financial Functions In Multinational Firms
 Finance is the Life Blood of the Business and so the case of MNCs also. The
only difference in finance of domestic companies and MNCs is that the finance
in domestic companies is in domestic currency where as in case of the MNCs
the finance is in multi currencies.
 Finance is required for many purposes like purchase of raw material, purchase
of machinery, purchases of the related items, payment of salaries, meeting the
operational expenses, etc., so the finance is required for all these purposes.
 There are three types of financing namely :-
 Short – Term Financing
 Financing Foreign Trade
 Long- Term Financing

4. Types of Financing
• Financing the working capital requirements of multinational companies’
foreign affiliate’s poses a complex decision problem.
• This complexity stems from the large number of financing options available
to the subsidiary of an MNC.
• Subsidiaries have access to funds from sister affiliates and the parent, as well
as external sources.
Short Term
Financing
• Foreign Trade is the main business of the traders of ever country. Almost all
the MNCs are heavily involved of foreign trade in addition to their other
international activities.
• Hence, the people who are responsible for the management of the MNCs must
have the practical knowledge of the institutions to facilitate the international
movement of goods.
Financing
Foreign Trade
• The following are the long term financing particularly for the capital
equipment's and other big items given to the MNCs who are actively engaged
in the Foreign Trade :-
• Export Financing
• Export Credit Subsidies and
• Export Credit Insurance
Long Term
Financing

5.  Finance and Treasury Functions in the Internalization Process
 Chief Financial Officer (CFO)—vice president of finance
 Responsible for controllership and treasury functions
 Acquires financial resources—generates funds from internal and external
sources
 Allocates financial resources—increases stockholders’ wealth by allocating
funds to different projects and investment opportunities
 Manages cash flows
Role of CFO

6. OPERATIONS
OBJECTIVES
STRATEGY
EXTERNAL INFLUENCES
COMPETITIVE
ENVIRONMENT
PHYSICALAND
SOCIETAL FACTORS
Functions
• Marketing
• Exporting and
importing
• Global manufacturing
• Supply chain
management
• Accounting
• FINANCE
• Human resources
Modes
MEANS
Overlaying
Alternatives
Finance in International Business

7. VP, Sales/Marketing
Controller
Cash Manager Credit Manager
Exposure
Management
Budget
Planning
Bid Support Process Foreign
Currency
Global Finance Capital
Expenditure
Financial
Planning
Treasurer
VP, Finance VP, Operations VP, R&D
President and COO
Chairman and CEO
Board of Directors
Location of Treasury Function in the Corporate
Organizational Structure

8. Capital Structure
 Companies follow financing trends in their own country and industry
 Companies can use local and international debt markets to raise funds
Leveraging
Debt
Financing
• The degree to which a firm funds the growth of the business by debt
• Interest on debt is tax deductible
• Amount of leverage used varies from country to country
Equity
Capital
• Capital—stocks or shares
• Dividends paid to investors are not deductible
• Choice of debt versus equity affected by a variety of factors
Debt
Markets
• Subsidiaries or foreign companies may find it easier to obtain credit than local
companies
• Back to back loan - made between a firm in country A with a subsidiary in
country B and a bank in country B with a branch in country A

9.  EUROCURRENCIES - any currency that is banked outside of its country of
origin
• Major sources of Eurocurrencies include:
– foreign governments or individuals who want to hold dollars outside of
the U.S.
– MNEs with excess cash
– European banks with excess foreign currency
– countries with large balance-of-trade surpluses held as reserves
• Characteristics of Eurocurrency market
– completely unregulated offshore market
– both short and medium term
– Eurocurrency deposits yield higher interest
– Eurocurrency loans tend to be cheaper
 LONDON INTER-BANK OFFERED RATE (LIBOR) - interest rate that banks
charge each other on Eurocurrency loans
Global Capital Markets

10. INTERNATIONAL BOND MARKET
An attractive place to borrow money that fills an important niche in financing
 Tends to be less expensive than local markets
 Foreign bonds - sold outside of the borrower’s country but in the currency
of the country of issue
 Eurobonds - underwritten by banking syndicate and sold in countries other
than the one in whose currency the bond is denominated
• sold in several financial centers
• some have currency options allowing the creditor to demand repayment
in one of several currencies
 Global bond - combination of domestic bond and Eurobond
• registered in each national market

11. Equity Securities and the Euromarkets
EQUITY SECURITIES
Investor takes an ownership position in return
for shares of stock, the promises of capital
gain, and dividends.
Many companies are using private
placements to raise equity capital
VENTURE CAPITALIST
Invests money in a new
venture in exchange for stock
EQUITY CAPITAL
MARKETS (stock markets)
Listing may be on home country
or foreign exchange
MARKET CAPITALIZATION
Total number of shares of stock listed times
the market price per share in part the increase
has resulted from privatization in emerging
markets and global economic growth

12. EUROEQUITY MARKET
Market for shares sold outside the issuing company’s home
country
Firms often list on only one big foreign exchange
e.g., 379 foreign companies listed on the New York Stock
Exchange
Companies with investments in several countries may list on
different exchanges
AMERICAN DEPOSITARY
RECEIPT (ADR)
A negotiable certificate issued
by a U.S. bank and
representing shares of stock
of a foreign company
GLOBAL DEPOSITARY
RECEIPTS and EUROPEAN
DEPOSITARY RECEIPTS
Other markets for Euro
equities
GLOBAL SHARE OFFERING
Simultaneous offering of actual
shares on different exchanges
Electronic trading of stocks is a
major source of competition for
stock exchanges

13. 1986
3.60%
96.40%
1994
12.70%
87.30%
1998
93.10%
6.90%
Emerging markets
Developed markets
Growth of Emerging Stock Markets

14. Cities or countries that engage in a variety of financial transactions
 Provide significant tax advantages
 Centers for the Eurocurrency market
 Markets are less regulated than domestic markets
 Provide an alternative, cheaper source of funding
 May be:
• Operational centers - extensive banking activities involving short-term
financial transactions
• Booking centers - little banking activity
• financial transactions recorded to take advantage of secrecy and low
tax rates
 Good locations for establishing financial subsidiaries
Offshore Financial Centers

15. Large foreign-
currency market
for loans/deposits
Offshore
Financial
Center
Good
communications
Pass-through for
international
loan funds
Efficient and
experienced
financial
community
Favorable
regulatory
climate
Economic and
political stability
Large net supplier
of funds to world
financial markets
Good supportive
services
Characteristics of Offshore Financial Centers

16. Internal Sources of Funds
FUNDS
Working capital, i.e., the
difference between
current assets and current
liabilities
Used to expand
operations or satisfy
demands for capital
SOURCES OF FUNDS
MNEs have more complex
arrangements due to the number
of subsidiaries and the diverse
environments in which they
operate
Loans
Dividends
Intercompany receivables and
payables
Investments through equity
capital
Funds may
flow from
subsidiaries
to parent or
vice versa

17. Dividends,
royalties,
and fees
French
Subsidiary
Brazilian
Subsidiary
Parent
Company
Loans
Extensions of
accounts payable
Invests more
equity capital
Loans
Guarantee
loans
Internal Sources of Working Capital for MNEs

18. GLOBAL CASH MANAGEMENT
Requires the collection and payment of cash resulting from the normal
operational cycle
 Generates and invests cash through dealings with financial institutions
 Assesses a company’s cash needs using budgets and forecasts
 Involves decisions about the degree of centralization of cash
• transfers of cash may be in the form of dividends, royalties, management
fees, and repayment of loans
• governments concerned about the outflow of foreign exchange may
curtail cash transfers abroad

19. MULTILATERAL NETTING
Company establishes one center to handle all internal cash, funds, and financial
transactions
 Enables companies to reduce the amount of cash flow and move cash more
quickly and efficiently
 Advantages include:
• optimizing the use of excess cash
• reducing interest expenses and maximizing interest yields
• reducing costly foreign exchange, swap transactions, and intercompany
transfers
• minimizing administrative paperwork
• centralizing and speeding information
 Multilateral cash flows in the absence of netting require each subsidiary to settle
intercompany obligations
• Not as advantageous as netting

20. German
Subsidiary
$150,000
$200,000 $200,000
$100,000 United Kingdom
Subsidiary
French
Subsidiary
$50,000
$50,000
$200,000
Italian
Subsidiary
Multilateral Cash Flows

21. French
Subsidiary
Italian
Subsidiary
German
Subsidiary
United Kingdom
Subsidiary
Clearing
Account
$100,000
$100,000$150,000
$150,000
Multilateral Netting

22. Foreign Exchange Risk Management
Translation
(accounting)
exposure
Transaction
(commitment)
exposure
Foreign
exchange
risk
Economic
(operational)
exposure

23.  Arises from converting financial statements expressed in foreign currencies into
home currency
 All foreign currency denominated assets and liabilities as well as revenues and
costs have to be translated in one basic currency
 Assets and liabilities translated at current exchange rate are exposed, and those
translated at historical rate are not exposed because we use the same rate in this
case. The exposure depends on the translation method to be used
 Combined effect of the exchange-rate change is either a net gain or loss
• Does not represent an actual cash flow effect because the cash is only
translated into dollars, not converted into dollars
TRANSLATION EXPOSURE

24.  Transaction exposure occurs when a company trades, borrows or lends in a foreign
currency, or sells fixed assets of its subsidiaries in a foreign country. All these
operations involve time delay between the commitment of the transaction (sale of
an asset, for example) and the receipt or delivery of the payment
 Arises because the receivable or payable changes in value as the exchange rate
changes
 In order to measure Transaction exposure, three techniques can be used:
 the firm can measure the variability of each currency in which it has some
transactions
 the measurement based on the correlation between two currencies is also used
 an increasingly implemented technique used for measurement is the VaR
(Value-at-Risk) model
TRANSACTION EXPOSURE

25.  Economic exposure measures the change in the present value of the firm resulting
from any change in the future cash flows of the firm caused by an unexpected
change in the exchange rates.
 Economic risk arises, when a multinational firm incurs costs in one currency and
generates sales in another. Changes in foreign exchange rates affect the
competitive position of the firm.
 Economic exposure (operating exposure) is potential for change in expected cash
flows that arise from the:
•Pricing of products
•Sourcing and cost of inputs
•Location of investments
•Competitive position of the company in markets
ECONOMIC EXPOSURE

26.  DEFINING AND MEASURING EXPOSURE
• MNE must forecast the degree of exposure in each major currency in which it
operates
• Exchange-rate movements are forecasted using in-house or external experts
 CREATING A REPORTING SYSTEM
• Substantial participation from foreign operations combined with central control
• Foreign input important to ensure forecasting effectiveness
• Central control of exposure protects resources more efficiently
 defines and controls overall company exposure
• MNEs should devise uniform reporting system for its subsidiaries
• Time periods of reports vary
• Final reporting should be at corporate level
Exposure-Management Strategy

27. Exposure-Management Strategy (Contd.)
CENTRALIZED POLICY
 Top management should determine hedging policy
 Corporate treasurer should be able to design and implement a cost-effective
program
 Some decisions must be decentralized in order to react quickly to changes in the
international monetary environment
 Some companies run hedging operations as profit centers and nurture in-house
trading desks
FORMULATING HEDGING STRATEGIES
 Safest position has exposed assets equal to exposed liabilities
 Operational strategies
• involve adjusting the flow of money and resources to reduce foreign-
exchange risk
• using local debt to balance local assets
• taking advantage of leads and lags for intercompany payments

28.  A lead strategy means collecting foreign-currency receivables before they are
due when the currency is expected to weaken, or paying foreign-currency
payables before they are due when a currency is expected to strengthen.
 A lag strategy means delaying collection of foreign-currency receivables if the
currency is expected to strengthen, or delaying payment of foreign-currency
payables when the currency is expected to weaken.
 Contractual arrangements
• Forward contract - Establishes a fixed exchange rate for future transactions
• Foreign-currency option - Purchaser has the right, but not the obligation, to
buy or sell a certain amount of foreign currency at a set exchange rate within
a specified period of time
• More flexible than forward contract

29. Capital Budgeting Decision in an International Context
 Capital budgeting is the process whereby MNEs determine which projects and
countries will receive capital investment funds.
 Parent company needs to compare the net present value or internal rate of return
of a foreign project with that of its other projects and with that of others
available
 Unique aspects of capital budgeting for foreign projects
• Parent cash flows must be distinguished from project cash flows
• Remittance of funds to the parent affected by differing tax systems, and
legal and political constraints on movement of funds
• Differing rates of inflation must be anticipated
• Parent must consider possible changes in exchange rates
• Must evaluate political risk in foreign market
• Terminal value is difficult to estimate

30. Taxation of Foreign Source Income
 International Tax Practices
 Taxing Branches and Subsidies
 Transfer Prices
 Double Taxation and Tax Credit

31. International Tax Practices
INTERNATIONAL
TAX PRACTISES
Difference in
Tax Practices
Differences in
Types of Taxes
Differences in
GAAP
Differences in
Tax Rates
Approaches to
Corporate Taxation
Separate
Entity
Approach
Integrated
System
Approach

32. Taxing Branches and Subsidies
FOREIGN BRANCH
• Foreign Branch Income
(or loss) is directly
included in the parent’s
taxable income
• If the branch suffers a
loss, the parent is
allowed to deduct that
loss from its taxable
income, reducing it
overall tax liability
FOREIGN
SUBSIDIARY
• A foreign corporation is an
independent legal entity set up in a
country according to the laws of
incorporation of that country.
• When an MNE purchases or
establishes such an entity, it is
called a subsidiary. Subsidiary
income is either taxable to the
parent or tax deferred (not taxed
until it is submitted as a dividend to
the parent).
CONTROLLED
FOREIGN
CORPORATION
• The tax status of a subsidiary
depends on whether the subsidiary
is a controlled foreign
corporation (CFC) and whether
the income is active or passive.
• Active income is derived from the
direct conduct of a trade or
business. Passive, or subpart F
income, comes from sources other
than those connected with the direct
conduct of a trade or business
(generally in tax haven countries).

33. Determining Subsidiary Income

34.  A price on goods and services one member of a corporate family sells to
another.
 Transfer pricing applies to transactions between related entities and is not
usually an arm’s length price (price between two unrelated entities).
 Transfer Prices and Taxation
• Companies establish arbitrary transfer prices because of differences in
taxation between countries.
• The OECD is concerned about how companies manipulate transfer prices to
minimize their tax liability worldwide.
Transfer Prices

35. Double Taxation and Tax Credit
 Value-added tax (VAT) has been in existence since 1967 in most Western
European countries. Under a VAT, each company pays a percentage of the value
added to a product at each stage of the business process. The EU has worked
hard to reduce and standardize VAT rates among its members.
 The purpose of tax treaties is to prevent double taxation or to provide remedies
when it occurs. When agreeing to a treaty, countries generally grant reciprocal
reduction on dividend withholding and exempt royalties, and sometimes interest
payments, from any withholding tax.
 Tax Treaties Eliminating Double Taxation
• The purpose of tax treaties is to prevent double taxation or to provide
remedies when it occurs.

36. Future: Technology and Cash Flows
• Greater emphasis on moving corporate cash worldwide to take
advantage of differing rates of return and minimize tax bills.
• OECD countries are trying to break barriers to bank secrecy.
• Technological innovation will allow companies to transfer funds
more quickly worldwide.