Question 18.14: A US multinational has its subsidiaries in India, UK and Fra......
A US multinational has its subsidiaries in India, UK and France. The multinational optimises its inter-subsidiary cash flow using the netting system and currency center located at its headquarters. Each subsidiary reports its payables to other subsidiaries, on the first day of each month, to the centre.
In their report, these subsidiaries also intimate the funds available with them and expected requirement of funds for operations by it in that month.
\, The currency center then issues instructions to the net paying subsidiary on the fifth of each month, using the market exchange rate on that date. Also, the currency center requires subsidiary companies to transfer their cash surplus to the currency center. Deficit subsidiaries are asked to cover their temporary needs by drawing on their overdraft facilities with local banks.
\, Following is the summary of the report sent by three subsidiary companies on March 1.
(a) Design a netting system for all three subsidiary companies.
(b) Determine the total funds available to the currency center for money market investment during
\, March.
(c) Which subsidiary will be using local overdrafts and of what amount?
| Funds\>required\>for operation \>March 1–31 |
Funds\>available \, |
Amounts\>due\>to\>other\>subsidiary \, |
Subsidiary \, |
| £ 3,000,000 to UK subsidiary | Indian (Rs) | ||
| Rs 20,000,000 | Rs 100,000,000 | Ff 4,000,000 to French subsidiary | |
| Rs 32,500,000 to Indian subsidiary | UK (£) | ||
| £ 2,000,000 | £ 50,000 | Ff 10,000,000 to French subsidiary | |
| Rs 150,000,000 to Indian subsidiary | France (Ff) | ||
| Ff 20,000,000 | Ff 50,000,000 | £ 2,000,000 to UK subsidiary |
Spot exchange rate on March 5, are as follows:
| $ 1 = Rs 48.00 |
| £ 1 = $ 1.60 |
| $ 1 = Ff 7.00 |
When positions are reported to the currency center, the center will convert these positions to US dollars using the spot exchange rate. The following matrix shows the amount due to and from one subsidiary to the other subsidiary in US dollars.
\, The matrix suggests that the Indian subsidiary as well as the French subsidiary have higher total payables than total receivables; the UK subsidiary has higher receivable than payable. In view of these facts, the currency center issues instructions to the Indian and French subsidiaries to make the following payments to the UK subsidiary in Pound sterling.
\, Indian subsidiary to UK subsidiary $ 1,569,345 ($ 5,371,428–$ 3,802,083) or £ 980,841 ($ 1,569,345/ $ 1.6)
French subsidiary to UK subsidiary $ 4,325,001 ($ 6,325,000–$1,999,999) or £ 2,703,126 ($ 4,325,001/ $ 1.6)
\, As the French subsidiary has a net deficit of Ff 275,007 for the month of March, it will use the local overdraft facility to tide over. The Indian subsidiary has a surplus of Rs 4,671,440 (or $ 97,321) and the UK subsidiary has a surplus of £ 1,733,967 (or $ 2,774,347). The Indian and UK subsidiary companies will transfer cash surplus to the centre. As a result, the currency center will have $ 2,871,668 ($ 97,321 + $ 2,774,347) to carry out money market investment during March.
\, Evidently, the temporarily idle cash balances need deployment in appropriate marketable securities to yield extra income. This apart, an MNC has to hedge its undesirable cash and marketable securities against foreign exchange rate risks. This can be achieved by various foreign exchange rate hedging methods (explained in Chapter 17). Forward contracts are by far the most commonly used hedging technique; other feasible techniques are borrowing or lending in different currencies, future contracts, options, interest rate swaps and currency swaps.
| Total\> payable | French\> subsidiary | UK\> subsidiary | Indian\> subsidiary | |
| 5,371,428 | 571,428 | 4,800,000 | — | Indian subsidiary |
| 2,105,654 | 1,428,571 | — | 677,083 | UK subsidiary |
| 6,325,000
|
—
|
3,200,000
|
3,125,000
|
French subsidiary |
| — | 1,999,999 | 8,000,000 | 3,802,083 | Total receivable |
The following resources are available to the three subsidiary companies after the netting process
| Surplus\>or\>(deficit) | Funds\>required | Total\>resources\>available | Currency | Subsidiary |
| Rs 4,671,440 | Rs 20,000,000 | Rs 100,000,000 – 75,328,560^@ | Rs | Indian |
| £ 1,733,967 | £ 2,000,000 | £ 50,000 + 3,683,967 | £ | UK |
| (Ff 275,007) | Ff 20,000,000 | Ff 50,000,000 – 30,275,007 | Ft | French |
^@($ 1,569,349 × Rs 48)