Chapter 20 – The Multinational Finance Function

 

Multiple Choice Questions

 

WHAT ARE THE MAJOR CORPORATE FINANCE AND TREASURY FUNCTIONS?

 

1.      The corporate finance function in a company focuses on:

a.      working capital management. (moderate, page 604)

b.      global supply chain management.

c.       research and development.

d.      short-term, but not long-term, cash flows.

 

2.      Which of the following major areas of cash flow activities determines the proper mix of debt and equity?

a.       capital budgeting

b.      capital structure (moderate, page 604)

c.       long-term financing

d.      working capital management

 

3.      Which of the following major areas of cash flow activities analyzes investment opportunities?

a.       capital structure

b.      long-term financing

c.       capital budgeting (moderate, page 604)

d.      working capital management

 

4.      _______________ is the selection, issuance, and management of long-term debt and equity capital, including location and currency.

a.       Capital structure

b.      Capital budgeting

c.       Working capital management

d.      Long-term financing (easy, page 604)

 

5.      The acquisition and allocation of financial resources is primarily the responsibility of:

a.      the chief financial officer. (easy, page 604)

b.      the head accountant.

c.       the head of financial marketing.

d.      the corporate controller.

 

WHAT ARE SOME CHALLENGES FOR MNEs USING DEBT AS A SOURCE OF CAPITAL IN DIFFERENT COUNTRIES?

 

6.      Because of the tax-deductibility of interest expense, _______________ is often perceived as the most cost effective route to capitalization.

a.       capitalizing

b.      leveraging (moderate, page 605)

c.       asset allocation

d.      capital budgeting

 

7.      Which of the following is true concerning the capital structure of an MNE?

a.       Country-specific factors are not important in determining capital structure.

b.      The debt/asset ratio is the same from country to country.

c.       Foreign subsidiaries of an MNE may have limited access to local capital markets. (difficult, page 605)

d.      Reliance on debt financing reduces financial risk.


 

8.      One of the major causes of the Asian Financial Crisis in 1997 was that companies:

a.       relied too much on bank debt to finance growth. (difficult, page 605)

b.      relied on equity capital more than debt capital.

c.       relied more on bonds than on bank debt.

d.      financed their debt in local currency instead of U.S. dollars.

 

  

WHAT IS A EUROCURRENCY (AS OPPOSED TO A “EURO”), AND WHAT ARE SOME OF ITS KEY CHARACTERISTICS AND USES?

 

9.      A Eurocurrency is:

a.       regulated by the Central Bank of the country where it is located.

b.      any currency banked outside its country of origin. (moderate, page 606)

c.       stronger than it is in its home market.

d.      any currency traded in Europe.

 

10.    _______________, which constitute a fairly consistent 65–80% of the Eurocurrency market, are dollars banked outside of the United States.

a.       Cross dollars

b.      Global dollars

c.       Eurodollars (moderate, page 606)

d.      National dollars

 

11.    A Eurocurrency loan with a maturity of one to five years is known as:

a.       Euroequity.

b.      syndication.

c.       Eurobond.

d.      Eurocredit. (moderate, page 606)

 

12.    Eurocurrency loans tend to be:

a.      made at a variable rate. (difficult, page 606)

b.      higher rate than the rate in the corresponding country.

c.       set by the government of the country in which the loan is being made.

d.      made only at a fixed rate.

 

13.    London Inter-Bank Offered Rate (LIBOR) is:

a.       the rate at which banks in London loan money to corporations.

b.      usually the same as the prime rate.

c.       the rate that London banks lend money.

d.      the interest rate that banks charge each other on Eurocurrency loans.  (difficult, page 606)

 

14.    A situation where several banks pool resources to extend credit to a borrower and spread the risk is:

a.       consolidation.

b.      translation.

c.       syndication (moderate, page 606).

d.      forfeiting.


 

CONTRAST A FOREIGN, EURO, AND GLOBAL BOND.  WHAT SHOULD COMPANIES CONSIDER WHEN DECIDING WHICH FORM OF BOND TO USE?

 

15.    A bond sold in a country other than the one in whose currency the bond is denominated is a:

a.       foreign bond.

b.      Eurobond. (moderate, page 607)

c.       global bond.

d.      domestic bond.

 

16.    A Swiss franc bond issued in Luxembourg by a British MNE is a:

a.       foreign bond.

b.      domestic bond.

c.       Eurobond. (moderate, page 607)

d.      global bond.

 

17.    A bond sold outside the borrower's country but denominated in the currency of the country of issue is a:

a.       global bond.

b.      domestic bond.

c.       Eurobond.

d.      foreign bond. (moderate, page 607)

 

18.    A British pound bond issued in London by a U.S. company is a:

a.      foreign bond. (moderate, page 607)

b.      global bond.

c.       Eurobond.

d.      domestic bond.

 

19.    A bond registered in different national markets simultaneously according to the registration requirements of each market is a:

a.       domestic bond.

b.      global bond. (moderate, page 607)

c.       foreign bond.

d.      Eurobond.

 

20.    Which of the following is true concerning Eurobonds?

a.       They are typically issued in denominations of $1,000 or less.

b.      They are registered bonds.

c.       They are listed on a stock exchange.

d.      They pay interest annually and are held in bearer form. (difficult, page 608).

 

WHAT ARE SOME APPROACHES TO USING STOCK MARKETS TO RAISE FUNDS?

 

21.    A source of financing is _______________, where an investor takes an ownership position in return for shares of stock in the company and the promises of capital gains.

a.       Eurodollars

b.      global bonds

c.       equity securities (moderate, page 609)

d.      Eurobonds


 

22.    In addition to private placements, companies can access the equity capital market, more commonly known as the:

a.       bond market.

b.      commodities market.

c.       foreign exchange market.

d.      stock market. (moderate, page 609)

 

23.    _______________ is the total number of shares of stock listed times the market price per share.

a.      Market capitalization (moderate, page 609)

b.      Asset utilization

c.       Current ratio

d.      Price/earning ratio

 

24.    Shares of stock issued by Ford Motor Company on the London Stock Exchange are:

a.       Eurobonds.

b.      euroequity. (moderate, page 610).

c.       not valid shares.

d.      cannot be traded outside of London,

 

25.    A negotiable certificate issued by a U.S. bank for trade in the United States that represents shares of stock on the German company, Seimens, is:

a.      an American Depositary Receipt (moderate, page 611).

b.      the always the same price as the underlying stock in the home country.

c.       a global rights issue as long as Seimens doesn’t sell the shares in other countries.

d.      a Eurobond, even though it is traded in the United States instead of Europe.

 

 

WHAT ARE OFFSHORE FINANCIAL CENTERS, AND WHY ARE THEY USED?

 

26.    Offshore financial centers:

a.       are found only in industrial countries due to political stability.

b.      are cities or countries that engage in a variety of financial transactions that provide significant tax advantages to companies and individuals who do business there. (difficult, page 613)

c.       typically are not allowed to deal in Eurodollars.

d.      are often hindered by an aggressive local regulatory climate.

 

27.    An offshore financial center where extensive banking activities are carried out is:

a.       a booking center.

b.      not in London due to strict bank laws.

c.       an operational center. (moderate, page 613)

d.      none of these

 

28.    An offshore financial center that specializes in the recording of transactions to take advantage of secrecy and low tax rates is:

a.      a booking center. (moderate, page 613)

b.      an operational center.

c.       not in London due to the strict bank laws there.

d.      none of these


 

WHAT ARE THE KEY ELEMENTS OF AN EFFECTIVE GLOBAL CASH MANAGEMENT SYSTEM?

 

29.    All of the following are questions that must be answered by the Chief Financial Officer to ensure effective cash management EXCEPT:

a.      How much cash should be invested in the World Trade Organization? (moderate, page 615)

b.      What are the local and corporate system needs for cash?

c.       How can the cash be withdrawn from subsidiaries and centralized?

d.      Once the cash has been centralized, what should be done with it?

 

30.    In making cash transfers to a centralized cash pool, which of the following is true?

a.       Loans are not a good way to transfer funds due to interest payments.

b.      Governments sometimes restrict the flow of dividends. (difficult, page 615)

c.       The size of dividends depends on royalty agreements.

d.      Governments and countries with large foreign debt are anxious to allow foreign corporations to transfer funds out.

 

31.    A cash management strategy that allows companies to reduce the amount of cash flow and move cash more quickly and efficiently is:

a.       intracompany dividend flows.

b.      transfer pricing.

c.       multilateral netting. (moderate, page 615)

d.      intracompany loans.

 

32.    The advantages of establishing clearing accounts and mechanisms for transferring funds across national boundaries include all of the following EXCEPT:

a.       optimizing the use of excess cash

b.      reducing interest expenses and maximizing interest yields

c.       minimizing administrative paperwork

d.      expanding training areas for expatriates (moderate, page 615)

 

 

WHAT IS FOREIGN CURRENCY TRANSLATION EXPOSURE, AND HOW CAN IT AFFECT AN MNE?

 

33.    A change in the exchange rate can result in different exposures for a company that include all of the following EXCEPT:

a.      cultural exposure (moderate, page 616)

b.      translation exposure

c.       transaction exposure

d.      economic exposure

 

34.    A foreign exchange exposure that arises because of a change in the value of exposed assets or liabilities of foreign currency financial statements is:

a.       foreign exposure.

b.      translation exposure. (moderate, page 616)

c.       economic exposure.

d.      transactions exposure.

 

35.    Translation exposure is where:

a.       reporting systems are inadequate.

b.      sourcing of parts and components changes as exchange rates changes.

c.       the value of an exposed asset of a foreign subsidiary changes as the exchange rate changes. (difficult, page 616)

d.      a receivable or payable changes in value as the exchange rate changes.

 

WHAT IS FOREIGN CURRENCY TRANSACTION EXPOSURE?  DOES THIS EXPOSURE RESULT IN AN ACTUAL CASH FLOW GAIN OR LOSS?

 

36.    Foreign exchange exposure that arises because of an increase or decrease in cash flows is:

a.       reporting exposure.

b.      inflation exposure.

c.       translation exposure.

d.      transaction exposure. (moderate, page 616)

 

37.    A transaction exposure is where:

a.      a receivable or payable changes in value as the exchange rate changes, resulting in a cash flow change. (difficult, page 616)

b.      reporting systems are inadequate.

c.       the value of an exposed asset of a foreign subsidiary changes as the exchange rate changes.

d.      sourcing of parts and components changes as exchange rates changes.

 

38.    A change in exchange rate can result in any of the following different exposures for a company EXCEPT:

a.       translation exposure

b.      cultural exposure  (moderate, page 616)

c.       transaction exposure

d.      economic exposure

 

WHAT IS ECONOMIC EXPOSURE?  HOW DOES IT ARISE?

 

39.    _______________, also known as operating exposure, is the potential for change in expected cash flows.

a.       Translation exposure

b.      Transaction exposure

c.       Economic exposure (moderate, page 617)

d.      Cultural exposure

 

40.    Which of the following types of exposure arises from the pricing of products, the sourcing and cost of inputs, and the location of investments?

a.       translation exposure

b.      transaction exposure

c.       cultural exposure

d.      economic exposure (moderate, page 617)

 

41.    Which of the following are true concerning forecasting exchange-rate movements?

a.      It is important to forecast the direction, magnitude, and timing of exchange-rate changes. (difficult, page 617)

b.      Companies always outsource exchange-rate forecasting due to the lack of internal expertise.

c.       Forecasting is too imprecise to be of value in exposure management.

d.      It is impossible to forecast exchange-rate to any degree of reliability.

 

WHAT ARE THE KEY ELEMENTS OF AN EXPOSURE-MANAGEMENT STRATEGY?

 

42.    Borrowing local currency to balance local currency assets is an example of which type of strategy?

a.       cost/benefit

b.      operational (moderate, page 617)

c.       economic

d.      contractual


 

43.    _______________ strategies involve adjusting the flow of money and resources in normal operations in order to reduce foreign exchange risk.

a.       Production

b.      Long-term

c.       Operational (moderate, page 617)

d.      Marketing

 

44.    Which of the following is NOT a key element of an exposure-management strategy?

a.       Define and measure exposure.

b.      Organize and implement a reporting system that monitors exposure and exchange-rate movements.

c.       Formulate strategies for hedging exposure.

d.      Adopt a policy assigning responsibility for maximizing—or hedging—exposure. (difficult, page 617)

 

WHAT ARE SOME HEDGING STRATEGIES THAT AN MNE CAN ADOPT?

 

45.    A hedging instrument that allows one to establish a fixed exchange rate for future transactions where delivery is required is a(n):

a.      forward contract. (moderate, page 619)

b.      option.

c.       investment contract.

d.      future spot contract.

 

46.    A hedging instrument that allows one to establish a fixed exchange rate for future transactions where delivery is not required is a(n):

a.       future spot contract.

b.      foreign-currency option. (moderate, page 619)

c.       investment contract.

d.      forward contract.

 

 

47.    A strategy in which a company delays collection of foreign-currency receivables if that currency is expected to strengthen is a:

a.       lead strategy.

b.      motion strategy.

c.       lag strategy. (easy, page 619)

d.      bad debt.

 

48.    A lead strategy means that:

a.       the company sells inexpensive products before it sells expensive products.

b.      a company enters into a forward contract before a liability is due.

c.       a company collects or pays as late as possible.

d.      a company collects foreign-currency receivables before they are due when the foreign currency is expected to weaken. (difficult, page 619)


 

Essay Questions                                                        

 

49.    In a short essay, discuss the responsibilities of the chief financial officer.

 

         Answer

One of the most important people on the management team, crucial to a company’s success, is the vice president of finance, also known as the chief financial officer (CFO). The finance function in the firm focuses on cash flows. The management activities related to cash flow can be divided into four major areas:

a.       Capital structure—determining the proper mix of debt and equity

b.      Capital budgeting—analyzing investment opportunities

c.       Long-term financing—selection, issuance, and management of long-term debt and equity capital, including location and currency

d.      Working capital management—proper management of the company’s currency assets and liabilities

 

The CFO acquires financial resources and allocates them among the company’s activities and projects. Acquiring resources means generating funds either internally or from sources external to the company at the lowest possible cost. The CFO’s job is more complex in a global environment than in the domestic setting because of forces such as foreign exchange risk, currency flows and restrictions, different tax rates and laws pertaining to the determination of taxable income, and regulations on access to capital in different markets.

         (moderate, page 604)

 

50.    What is a Eurocurrency (as opposed to a “euro”), and what are some of its key characteristics and uses?

 

         Answer

A Eurocurrency is any currency that is banked outside of its country of origin. Currencies banked inside of their country of origin are also known as onshore, and currencies banked outside of their country of origin are also known as offshore. In essence, the Eurocurrency market is an offshore market. The major sources of Eurocurrencies are:

a.       foreign governments or individuals who want to hold dollars outside of the United States

b.      multinational corporations that have cash in excess of current needs

c.       European banks with foreign currency in excess of current needs

d.      countries such as Germany, Japan, and Taiwan that have large balance-of-trade surpluses held as reserves

 

The demand for Eurocurrencies comes from sovereign governments, supranational agencies such as the World Bank, companies, and individuals. Eurocurrencies exist partly for the convenience and security of the user and partly because of cheaper lending rates for the borrower and better yield for the lender. The Eurocurrency market is a wholesale rather than a retail market, so transactions are very large.

         (difficult, page 606)

 

51.    Contrast a foreign, euro, and global bond.  What should companies consider when deciding which form of bond to use?

 

         Answer

Foreign bonds are sold outside of the borrower’s country but are denominated in the currency of the country of issue. For example, a French company floating a bond issue in Swiss francs in Switzerland would be selling a foreign bond. Foreign bonds typically make up about 18% of the international bond market. A Eurobond is usually underwritten by a syndicate of banks from different countries and sold in countries other than the one in whose currency the bond is denominated. A bond issue floated by a U.S. company in dollars in London, Luxembourg, and Switzerland is a Eurobond. The global bond introduced by the World Bank in 1989 is a combination of a domestic bond and a Eurobond in that it must be registered in each national market according to that market’s registration requirements.

         (difficult, page 607)

 

52.    What are some approaches to using stock markets to raise funds?

 

         Answer

Equity securities is a source of financing where an investor takes an ownership position in return for shares of stock in the company and the promise of capital gains. One way a company can get access to capital is through a private placement with a venture capitalist. In addition to private placements, companies can access the equity-capital market, more commonly known as the stock market. Companies can raise new capital by listing their stocks on a stock exchange, and they can list on their home-country exchange or on a foreign exchange.

         (moderate, page 609)

 

53.    What is an ADR, and how can foreign companies use an ADR to raise capital in the United States?

 

         Answer

         An American Depositary Receipt (ADR) is a negotiable certificate issued by a U.S. bank that represents shares of stock of a foreign corporation.  ADRs are traded like shares of stock, with each one representing a specific number of shares of the underlying stock.  It may be 1 to 1, more than that or even less than one to one.  The ADR allows the foreign firm to raise capital in the United States without having to comply with all of the reporting requirements on the U.S. stock exchanges. 

(difficult, page 611-612)

 

54.   In a short essay, discuss four major reasons why a foreign company should list on the New York Stock Exchange.

 

         Answer

a.       NYSE provides opportunities to develop a broad shareholder constituency in the United States through exposure to the widest possible range of individual and institutional investors.

b.      NYSE facilitates U.S. mergers and acquisitions through the use of an NYSE-listed security as acquisition currency.

c.       NYSE increases the visibility of a company, its products and services, and the trading of its shares in the U.S.

d.      NYSE supports a company’s incentive program for its U.S. employees by providing a liquid market in the United States for its shares.

               (moderate, page 611)

 

55.    What are offshore financial centers, and why are they used?

 

         Answer

Offshore financial centers are cities or countries that engage in a variety of financial transactions and that provide significant tax advantages to companies and individuals who do business there. These centers provide an alternative, usually cheaper, source of funding for MNEs so that they don’t have to rely strictly on their own national markets. Offshore financial centers have one or more of the following characteristics:

a.      a large foreign-currency market for deposits and loans

b.     a market that  is a large net supplier of funds to the world financial markets

c.      a market that  is an intermediary or pass-through for international loan funds

d.     economic and political stability

e.      an efficient and experienced financial community

f.      good communications and supportive services

g.      an official regulatory climate favorable to the financial industry, in the sense that it protects investors without unduly restricting financial institutions

         (difficult, page 613)


 

56.    In a short essay, discuss multilateral netting.

 

         Answer

An important cash-management strategy is netting cash flows internationally. Netting means a company establishes one center to handle all internal cash/funds/financial transactions. The advantages of establishing their clearing accounts and mechanisms for transferring funds across national boundaries include:

a.       optimizing the use of excess cash.

b.      reducing interest expenses and maximizing interest yields.

c.       reducing costly foreign exchange, swap transactions, and intercompany transfers.

d.      minimizing administrative paperwork.

e.       centralizing and speeding information for tighter control and improved decision making.

               (moderate, page 615)

 

57.    What is foreign currency translation exposure, and how can it affect an MNE?

 

         Answer

Foreign-currency financial statements are translated into the reporting currency of the parent company so that they can be combined with financial statements of other companies in the corporate group to form the consolidated financial statements. Exposed accounts either gain or lose value in dollars when the exchange rate changes. The combined effect of the exchange-rate change on all assets and liabilities is either a net gain or loss. However, the gain or loss does not represent an actual cash-flow effect because the cash is only translated into dollars, not converted into dollars. The problem is that reported earnings can either rise or fall against the dollar because of the translation effect, and this can affect earnings per share and stock prices.

         (easy, page 616)

 

58.    What is economic exposure?  How does it arise?

 

         Answer

Economic exposure, also known as operating exposure, is the potential for change in expected cash flows. Economic exposure arises from the pricing of products, the sourcing and cost of inputs, and the location of investments.

         (easy, page 617)

 

59.    What are the key elements of an exposure-management strategy?

 

         Answer

         To protect assets adequately against risks from translation, transaction, and economic exposure of exchange-rate fluctuations, management must:

a.       define and measure exposure.

b.      organize and implement a reporting system that monitors exposure and exchange-rate movements.

c.       adopt a policy assigning responsibility for minimizing exposure.

d.      formulate strategies for hedging exposure.

               (moderate, page 617)