APPENDIX 17

A.17.1 LINEAR PROGRAMMING FORMULATION OF NETTING

A US parent company has subsidiaries in Canada, UK, Germany, The Netherlands
and South Korea. Table A.16.1 shows the intra-corporate receivables and payables
reported to the CMC at the parent HQ on the 15th of a particular month. The
amounts shown are dollar equivalents of the actual flows to be settled.

Table A.17.1
Intra-Corporate Receivables and Payables
(US$ Million)

Table A.17.2 shows the net amounts to be paid or received by each unit after
netting :

TABLE A.17.2
Net Amounts to be Paid or Received ($ Million)
______________________________________________________
Unit
Total Receivables
Total Payables
Net
______________________________________________________
CANADA
20.80
28.05
-7.25
UK
14.75
21.80
-7.05
GERMANY
30.00
9.90
+20.10
HOLLAND
15.40
13.50
+1.90
S.KOREA
10.90
25.80
-14.90
US
28.60
21.40
+7.20
_______________________________________________________
The CMC must decide the amounts to be transferred between the units so that
each surplus unit receives an amount equal to its net surplus and each deficit unit
pays an amount equal to its net deficit. Table A.17.3 shows these amounts in
algebraic notation. Thus X1 is the amount to be paid by UK to Germany, X5 is the
amount to be paid by Canada to Holland etc. The row total for each paying unit
equals its net deficit and the column total for each receiving country equals its net
surplus. The numbers in the top-right corner of each cell show the cost of
transferring the funds as percent of the amount to be transferred1. It is assumed that
these percentages do not vary with the amounts to be transferred.

These numbers are purely illustrative and therefore hypothetical.

Table A.17.3

The objective of the CMC is to determine the values of X1 ....X9 so as to

minimise the total cost of transferring funds with the constraint mentioned above
viz. each surplus unit must receive its net surplus and each deficit unit must pay its
net deficit.
This is a very simple linear programming problem of a special type known as
transportation problem. The can minimize the total cost of funds transfer while
ensuring that each unit pays or receives the net payment due from it or to it.
Mathematically it can be formulated as follows :
Minimise: (0.001X1 + 0.001X2 + 0.0012X3 + 0.0015X4 + 0.0015X5 + 0.001X6
+ 0.0018X7 + 0.0018X8 + 0.0016X9) ..
Subject to the constraints :
X1 + X2 + X3 = 7.05 Total payments from UK
X4 + X5 + X6 = 7.25 Total payments from Canada
X7 + X8 + X9 = 14.90 Total payments from S.Korea
X1 + X4 + X7 = 20.10 Total payments to Germany
X2 + X5 + X8 = 1.90 Total payments to Holland

X3 + X6 + X9 = 7.20 Total payments to US.

This problem can be solved by one of the standard methods in mathematical
programming2. The optimal solution is exhibited in Table A.17.4. The amounts are in
millions of dollars.

Table A.17.4
Optimum Funds Transfers

The optimal solution involves five funds transfers and the total cost works out
to $41,145.

See any basic text on Operations Research or Mathematical Programming. The optimal
solution need not be unique.
2