Chapter 8
Short-Term Financing
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Objectives
This chapter explains short-term liability management of MNCs, a part of multinational management that is often neglected in other textbooks. From this chapter, we should learn that correct financing decisions can reduce the firm’s costs and maximize the value of the MNC. While foreign financing costs cannot usually be perfectly forecasted, firms should evaluate the probability of reducing costs through foreign financing. The specific objectives are:
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Pre-class Discussion
1. If a firm consistently exports to a country with low interest rates and needs to consistently borrow funds, explain how it could coordinate its invoicing and financing to reduce its financing costs.
currency over the life of the loan. Example: how to compute the effective
financing rate
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How to compute the effective
financing rate (Example)
• Dearborn, Inc. (based in Michigan), obtains a one-year
• MNCs utilize direct Eurobank loans to maintain a relationship with the banks too.
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Why MNCs Consider Foreign Financing
• An MNC may finance in a foreign currency to offset a net receivables position in that foreign currency.
loan of $1,000,000 in New Zealand dollars (NZ$) at the quoted interest rate of 8 percent. When Dearborn receives the loan, it converts the NZ$ to US$ to pay a supplier for materials. The exchange rate at that time is $.50, so the NZ$1,000,000 is converted to $500,000 (1,000,000 * $.50). One year later, Dearborn pays back the loan of NZ$1,000,000 plus interest of NZ$80,000 (8%*NZ$1,000,000). Thus, the total amount in New Zealand dollars needed by Dearborn is NZ$1,080,000 (1,000,000+80,000). Assume the New Zealand dollar appreciates from $.50 to $.60 by the time the loan is to be repaid. Dearborn will need to convert $648,000
• 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.
• An MNC may also consider borrowing foreign currencies when the interest rates on such currencies are attractive, so as to reduce the costs of financing.
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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.
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Internal Fபைடு நூலகம்nancing by MNCs
• Before an MNC’s parent or subsidiary searches for outside funding, it should determine if any internal funds are available.
2. What is the risk of borrowing a low interest rate currency?
3. Assume that foreign currencies X,Y, and Z are highly correlated. If a firm diversifies its financing among these three currencies, will it substantially reduce its exchange rate exposure? Explain.
• Parents of MNCs may also raise funds by increasing their markups on the supplies that they send to their subsidiaries.
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Sources of Short-Term Financing
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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