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Lecture Multinational financial management: Lecture 23 - Dr. Umara Noreen

After completing this chapter, students will be able to: To explain why MNCs consider foreign financing; to explain how MNCs determine whether to use foreign financing; and to illustrate the possible benefits of financing with a portfolio of currencies. | Short-Term Financing 23 Lecture Chapter Objectives To explain why MNCs consider foreign financing; To explain how MNCs determine whether to use foreign financing; and To illustrate the possible benefits of financing with a portfolio of currencies. Sources of Short-Term Financing Euronotes are unsecured debt securities with typical maturities of 1, 3 or 6 months. They are underwritten by commercial banks. MNCs may also issue Euro-commercial papers to obtain short-term financing. MNCs utilize direct Eurobank loans to maintain a relationship with Eurobanks too. Internal Financing by MNCs Before an MNC’s parent or subsidiary searches for outside funding, it should determine if any internal funds are available. Parents of MNCs may also raise funds by increasing their markups on the supplies that they send to their subsidiaries. Why MNCs Consider Foreign Financing An MNC may finance in a foreign currency to offset a net receivables position in that foreign currency. An MNC may also consider | Short-Term Financing 23 Lecture Chapter Objectives To explain why MNCs consider foreign financing; To explain how MNCs determine whether to use foreign financing; and To illustrate the possible benefits of financing with a portfolio of currencies. Sources of Short-Term Financing Euronotes are unsecured debt securities with typical maturities of 1, 3 or 6 months. They are underwritten by commercial banks. MNCs may also issue Euro-commercial papers to obtain short-term financing. MNCs utilize direct Eurobank loans to maintain a relationship with Eurobanks too. Internal Financing by MNCs Before an MNC’s parent or subsidiary searches for outside funding, it should determine if any internal funds are available. Parents of MNCs may also raise funds by increasing their markups on the supplies that they send to their subsidiaries. Why MNCs Consider Foreign Financing An MNC may finance in a foreign currency to offset a net receivables position in that foreign currency. An MNC may also consider borrowing foreign currencies when the interest rates on such currencies are attractive, so as to reduce financing costs. Short-Term Interest Rates as of February 2004 Determining the Effective Financing Rate The actual cost of financing depends on the interest rate on the loan, and the movement in the value of the borrowed currency over the life of the loan. 2. Converts to $500,000 Exchange rate = $0.50/NZ$ What is the effective financing rate? 3. Has to pay back NZ$1,080,000 1 year later 1. Borrows NZ$1,000,000 at 8.00% for 1 year At time t 4. Converts to $648,000 Exchange rate = $0.60/NZ$ Determining the Effective Financing Rate $648k – $500k = 29.6% ! $500k The effective financing rate, rf , can be written as: rf = (1 + if )(1 + ef ) – 1 where if = the foreign currency interest rate ef = the % in the foreign currency’s spot rate = St+1 – S S Determining the Effective Financing Rate Criteria Considered for Foreign Financing There are various criteria an MNC must consider in its .