|
|
|
|
|
|
|
Texts belong to their owners and are placed on a site for acquaintance. |
Techniques For Global Money Management We now look at two money management techniques firms use in attempting to manage their global cash resources in the most efficient manner: centralized depositories and multilateral netting. Centralized Depositories Every business needs to hold some cash balances for servicing accounts that must be paid and for insuring against unanticipated negative variation from its projected cash flows. The critical issue for an international business is whether each foreign subsidiary should hold its own cash balances or whether cash balances should be held at a centralized depository. In general, firms prefer to hold cash balances at a centralized depository for three reasons. First, by pooling cash reserves centrally, the firm can deposit larger amounts. Cash balances are typically deposited in liquid accounts, such as overnight money market accounts. Because interest rates on such deposits normally increase with the size of the deposit, by pooling cash centrally, the firm should be able to earn a higher interest rate than it would if each subsidiary managed its own cash balances. Second, if the centralized depository is located in a major financial center (e.g., London, New York, or Tokyo), it should have access to information about good short-term investment opportunities that the typical foreign subsidiary would lack. Also, the financial experts at a centralized depository should be able to develop investment skills and know - how that managers in the typical foreign subsidiary would lack. Thus, the firm should make better investment decisions if it pools its cash reserves at a centralized depository. Third, by pooling its cash reserves, the firm can reduce the total size of the cash pool it must hold in highly liquid accounts, which enables the firm to invest a larger amount of cash reserves in longer-term, less liquid financial instruments that earn a higher interest rate. For example, a US firm has three foreign subsidiaries--one in Spain, one in Italy, and one in Germany. Each subsidiary maintains a cash balance that includes an amount for dealing with its day-to-day needs plus a precautionary amount for dealing with unanticipated cash demands. The firm's policy is that the total required cash balance is equal to three standard deviations of the expected day-to-day-needs amount. The three-standard-deviation requirement reflects the firm's estimate that, in practice, there is a 99.87 percent probability that the subsidiary will have sufficient cash to deal with both day-to-day and unanticipated cash demands. Cash needs are assumed to be normally distributed in each country and independent of each other (e.g., cash needs in Germany do not affect cash needs in Italy). The individual subsidiaries' day-to-day cash needs and the precautionary cash balances they should hold are as follows (in millions of dollars):
Thus, the Spanish subsidiary estimates that it must hold $10 million to serve its day-to-day needs. The standard deviation of this is $1 million, so it is to hold an additional $3 million as a precautionary amount. This gives a total required cash balance of $13 million. The total of the required cash balances for all three subsidiaries is $46 million. Now consider what might occur if the firm decided to maintain all three cash balances at a centralized depository in London. Because variances are additive when probability distributions are independent of each other, the standard deviation of the combined precautionary account would be: Therefore, if the firm used a centralized depository, it would need to hold $28 million for day-to-day needs plus (3 x $3,741,657) as a precautionary amount, or a total cash balance of $39,224,972. In other words, the firm's total required cash balance would be reduced from $46 million to $39,224,972, a saving of $6,775,028. This is cash that could be invested in less liquid, higher-interest accounts or in tangible assets. The saving arises simply due to the statistical effects of summing the three independent, normal probability distributions. However, a firm's ability to establish a centralized depository that can serve short-term cash needs might be limited by government-imposed restrictions on capital flows across borders (e.g., controls put in place to protect a country's foreign exchange reserves). Also, the transaction costs of moving money into and out of different currencies can limit the advantages of such a system. Despite this, many firms hold at least their subsidiaries' precautionary cash reserves at a centralized depository, having each subsidiary hold its own day-to-day-needs cash balance. The globalization of the world capital market and the general removal of barriers to the free flow of cash across borders (particularly among advanced industrialized countries) are two trends likely to increase the use of centralized depositories. Multilateral Netting Multilateral netting allows a multinational firm to reduce the transaction costs that arise when many transactions occur between its subsidiaries. These transaction costs are the commissions paid to foreign exchange dealers for foreign exchange transactions and the fees charged by banks for transferring cash between locations. The volume of such transactions is likely to be particularly high in a firm that has a globally dispersed web of interdependent value creation activities. Netting reduces transaction costs by reducing the number of transactions. Multilateral netting is an extension of bilateral netting. Under bilateral netting, if a French subsidiary owes a Mexican subsidiary $6 million and the Mexican subsidiary simultaneously owes the French subsidiary $4 million, a bilateral settlement will be made with a single payment of $2 million from the French subsidiary to the Mexican subsidiary, the remaining debt being canceled. Under multilateral netting, this simple concept is extended to the transactions between multiple subsidiaries within an international business. Consider a firm that wants to establish multilateral netting among four European subsidiaries based in Germany, France, Spain, and Italy. These subsidiaries all trade with each other, so at the end of each month a large volume of cash transactions must be settled. Figure 20.2a shows how the payment schedule might look at the end of a given month. Figure 20.2b is a payment matrix that summarizes the obligations among the subsidiaries. Figure 20.2a Cash Flows before Multilateral Netting
Figure 20.2b Calculation of Net Receipts (all amounts in millions)
Figure 20.2c Cash Flows after Multilateral Netting Note that $43 million needs to flow among the subsidiaries. If the transaction costs (foreign exchange commissions plus transfer fees) amount to 1 percent of the total funds to be transferred, this will cost the parent firm $430,000. However, this amount can be reduced by multilateral netting. Using the payment matrix (Figure 20.2b), the firm can determine the payments that need to be made among its subsidiaries to settle these obligations. Figure 20.2c shows the results. By multilateral netting, the transactions depicted in Figure 20.2a are reduced to just three; the German subsidiary pays $3 million to the Italian subsidiary, and the French subsidiary pays $1 million to the Spanish subsidiary and $1 million to the Italian subsidiary. The total funds that flow among the subsidiaries are reduced from $43 million to just $5 million, and the transaction costs are reduced from $430,000 to $50,000, a savings of $380,000 achieved through multilateral netting. |
|||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||
