Description
Describes sources short term financing sources, reasons why MNCs consider foreign financing.
International Corporate Finance
Financing Short-Term Commitments
Group 5
Short term financing sources
• 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 the banks too.
International Money Market
• Eurocurrency is a time deposit in an international bank located in a country different than the country that issued the currency.
– For example, Eurodollars are U.S. dollardenominated time deposits in banks located abroad. – Euroyen are yen-denominated time deposits in banks located outside of Japan. – The foreign bank doesn’t have to be located in Europe.
Eurocurrency Market
• Most Eurocurrency transactions are interbank transactions in the amount of $1,000,000 and up. • Common reference rates include
– LIBOR: the London Interbank Offered Rate – PIBOR: the Paris Interbank Offered Rate – SIBOR: the Singapore Interbank Offered Rate – EURIBOR: the rate at which interbank time deposits of are offered by one prime bank to another
Eurocredits
• Eurocredits are short- to medium-term loans of Eurocurrency. • The loans are denominated in currencies other than the home currency of the Eurobank. • Often the loans are too large for one bank to underwrite; a number of banks form a syndicate to share the risk of the loan. • Eurocredits feature an adjustable rate. On Eurocredits originating in London the base rate is LIBOR.
Euronotes
• Euronotes are short-term notes underwritten by a group of international investment banks or international commercial banks. • They are sold at a discount from face value and pay back the full face value at maturity. • Maturity is typically three to six months. • Euronotes are slightly less expensive than Eurobank Loans
Euro Medium-Term Notes
• Typically fixed rate coupon paying notes issued by a corporation. • Maturities range from less than a year to about ten years. • Euro-MTNs is partially sold on a continuous basis –this allows the borrower to raise funds as they are needed.
Eurocommercial Paper
• Unsecured short-term promissory notes issued by corporations and banks. • Placed directly with the public through a dealer. • Maturities typically range from one month to six months. • Sold at discount, redeemed at par. • Eurocommercial paper, while typically U.S. dollar denominated, is often of lower quality than U.S. commercial paper—as a result yields are higher.
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.
– May help circumvent restrictions and taxes
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 the costs of financing.
Offsetting Receivables
• • • • • • Net receivables in Euros Current Need of Dollars Strategy: Borrow Euros & convert into Dollars Use the net receivables to repay the Euro Loan Helps minimize exchange rate exposure Useful if foreign interest rate is low
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.
Determining the Effective Financing Rate
Effective financing rate, Rf = (1 + if ) [ 1+ (St+1 – St)/St ]- 1
where if = the interest rate on the loan St = beginning spot rate St+1 = ending spot rate
The effective rate can be rewritten as rf = ( 1 + if ) ( 1 + ef ) – 1 where ef = the % D in the spot rate
Example: Dearborn Inc.
At time t 1. Borrows NZ$1,000,000 at 8.00% for 1 year 1 year later 3. Has to pay back NZ$1,080,000
Exchange rate = $0.50/NZ$ What is the effective financing rate?
Exchange rate = $0.60/NZ$
2. Converts to $500,000
4. Converts to $648,000
$648k – $500k = 29.6% $500k
Example: Dearborn Inc.
At time t 1. Borrows NZ$1,000,000 at 8.00% for 1 year 1 year later 3. Has to pay back NZ$1,080,000
Exchange rate = $0.50/NZ$ What is the effective financing rate?
Exchange rate = $0.45/NZ$
2. Converts to $500,000
4. Converts to $486,000
$486k – $500k = -2.8% $500k
Criteria Considered for Foreign Financing
• There are various criteria an MNC must consider in its financing decision, including
– interest rate parity, – the forward rate as a forecast, and – exchange rate forecasts.
Interest Rate Parity
• If IRP holds, foreign financing with a simultaneous hedge of that position in the forward market will result in financing costs similar to those for domestic financing.
Implications of IRP for Financing
IRP holds? Yes Yes Yes Yes Forward rate accurately predicts future spot rate Scenario Type of financing Covered Uncovered Uncovered Uncovered Financing costs* Similar Similar Lower Higher
Forward rate overestimates future spot rate
Forward rate underestimates future spot rate Forward premium(discount) exceeds (is less than) interest rate differential Forward premium (discount) is less than (exceeds) interest rate differential
No
Covered
Higher
No
Covered
Lower
* as compared to the financing costs for domestic financing
Forward Rate as forecast
• Rf = (1 + if ) [ 1+ (St+1 – St)/St ]- 1 • Based on Expected forward rate: Rf = (1 + if ) [ 1+ (F – S)/S ]- 1
• If the forward rate is an unbiased predictor of the future spot rate, then the effective financing rate of a foreign loan will on average be equal to the domestic financing rate • If Future spot rate < Forward Rate, lower effective financing rate • If Future spot rate > Forward Rate, higher effective financing rate (for uncovered forex position)
Exchange Rate Forecasts
• Firms may use exchange rate forecasts to forecast the effective financing rate of a foreign currency, or they may compute the break-even exchange rate that will equate the domestic and foreign financing rates. • Sometimes, it may be useful to develop probability distributions, instead of relying on single point estimates.
Exchange Rate Forecasts
• Sarasota Inc. needs funds for one year • Rate- US: 12% ; Swiss: 8% • Expected appreciation in CHF: 2 %
E(Rf ) = (1 + if ) [ 1+ E(ef) ]- 1 = (1.08)(1.02)- 1 = 0.1016 i.e. 10.16% Breakeven ef = 3.703% (for US rate and Swiss effective rate to be equal)
Exchange Rate Forecasts
• Use of Probability Distributions
Change in CHF Value Effective Financing Rate Probability -6% 0.0152 5% -4% 0.0368 10% -1% 0.0692 15% 1% 0.0908 20% 4% 0.1232 20% 6% 0.1448 15% 8% 0.1664 10% 10% 0.188 5% 0.10538
Expected Rate ?
Financing with a Portfolio of Currencies
• While foreign financing can result in significantly lower financing costs, the variance in the costs is higher. • MNCs may be able to achieve lower financing costs without excessive risk by financing with a portfolio of currencies. • If the chosen currencies are not highly positively correlated, they will not be likely to experience a high level of appreciation simultaneously.
Financing with a Portfolio of Currencies (contd.)
• Thus, the chances that the portfolio’s effective financing rate will exceed the domestic financing rate are reduced. • A firm that repeatedly finances in a currency portfolio will normally prefer to compose a financing package that exhibits a somewhat predictable effective financing rate on a periodic basis. • When comparing different financing packages, the variance can be used to measure how volatile a portfolio’s effective financing rate is.
Financing with a Portfolio of Currencies
For a two-currency portfolio,
E(rP) = wAE(rA) + wBE(rB)
where rP = the effective financing rate of the portfolio rX = the effective financing rate of currency X wX = the % of total funds financed from currency X
Financing with a Portfolio of Currencies
Var(rP) = wA2?A2 + wB2?B2 + 2wAwB?A?BCORRAB
For a two-currency portfolio, ?X2 = the variance of currency X’s effective financing rate CORRAB = the correlation coefficient of the two currencies’ effective finance rates
doc_690098248.ppt
Describes sources short term financing sources, reasons why MNCs consider foreign financing.
International Corporate Finance
Financing Short-Term Commitments
Group 5
Short term financing sources
• 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 the banks too.
International Money Market
• Eurocurrency is a time deposit in an international bank located in a country different than the country that issued the currency.
– For example, Eurodollars are U.S. dollardenominated time deposits in banks located abroad. – Euroyen are yen-denominated time deposits in banks located outside of Japan. – The foreign bank doesn’t have to be located in Europe.
Eurocurrency Market
• Most Eurocurrency transactions are interbank transactions in the amount of $1,000,000 and up. • Common reference rates include
– LIBOR: the London Interbank Offered Rate – PIBOR: the Paris Interbank Offered Rate – SIBOR: the Singapore Interbank Offered Rate – EURIBOR: the rate at which interbank time deposits of are offered by one prime bank to another
Eurocredits
• Eurocredits are short- to medium-term loans of Eurocurrency. • The loans are denominated in currencies other than the home currency of the Eurobank. • Often the loans are too large for one bank to underwrite; a number of banks form a syndicate to share the risk of the loan. • Eurocredits feature an adjustable rate. On Eurocredits originating in London the base rate is LIBOR.
Euronotes
• Euronotes are short-term notes underwritten by a group of international investment banks or international commercial banks. • They are sold at a discount from face value and pay back the full face value at maturity. • Maturity is typically three to six months. • Euronotes are slightly less expensive than Eurobank Loans
Euro Medium-Term Notes
• Typically fixed rate coupon paying notes issued by a corporation. • Maturities range from less than a year to about ten years. • Euro-MTNs is partially sold on a continuous basis –this allows the borrower to raise funds as they are needed.
Eurocommercial Paper
• Unsecured short-term promissory notes issued by corporations and banks. • Placed directly with the public through a dealer. • Maturities typically range from one month to six months. • Sold at discount, redeemed at par. • Eurocommercial paper, while typically U.S. dollar denominated, is often of lower quality than U.S. commercial paper—as a result yields are higher.
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.
– May help circumvent restrictions and taxes
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 the costs of financing.
Offsetting Receivables
• • • • • • Net receivables in Euros Current Need of Dollars Strategy: Borrow Euros & convert into Dollars Use the net receivables to repay the Euro Loan Helps minimize exchange rate exposure Useful if foreign interest rate is low
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.
Determining the Effective Financing Rate
Effective financing rate, Rf = (1 + if ) [ 1+ (St+1 – St)/St ]- 1
where if = the interest rate on the loan St = beginning spot rate St+1 = ending spot rate
The effective rate can be rewritten as rf = ( 1 + if ) ( 1 + ef ) – 1 where ef = the % D in the spot rate
Example: Dearborn Inc.
At time t 1. Borrows NZ$1,000,000 at 8.00% for 1 year 1 year later 3. Has to pay back NZ$1,080,000
Exchange rate = $0.50/NZ$ What is the effective financing rate?
Exchange rate = $0.60/NZ$
2. Converts to $500,000
4. Converts to $648,000
$648k – $500k = 29.6% $500k
Example: Dearborn Inc.
At time t 1. Borrows NZ$1,000,000 at 8.00% for 1 year 1 year later 3. Has to pay back NZ$1,080,000
Exchange rate = $0.50/NZ$ What is the effective financing rate?
Exchange rate = $0.45/NZ$
2. Converts to $500,000
4. Converts to $486,000
$486k – $500k = -2.8% $500k
Criteria Considered for Foreign Financing
• There are various criteria an MNC must consider in its financing decision, including
– interest rate parity, – the forward rate as a forecast, and – exchange rate forecasts.
Interest Rate Parity
• If IRP holds, foreign financing with a simultaneous hedge of that position in the forward market will result in financing costs similar to those for domestic financing.
Implications of IRP for Financing
IRP holds? Yes Yes Yes Yes Forward rate accurately predicts future spot rate Scenario Type of financing Covered Uncovered Uncovered Uncovered Financing costs* Similar Similar Lower Higher
Forward rate overestimates future spot rate
Forward rate underestimates future spot rate Forward premium(discount) exceeds (is less than) interest rate differential Forward premium (discount) is less than (exceeds) interest rate differential
No
Covered
Higher
No
Covered
Lower
* as compared to the financing costs for domestic financing
Forward Rate as forecast
• Rf = (1 + if ) [ 1+ (St+1 – St)/St ]- 1 • Based on Expected forward rate: Rf = (1 + if ) [ 1+ (F – S)/S ]- 1
• If the forward rate is an unbiased predictor of the future spot rate, then the effective financing rate of a foreign loan will on average be equal to the domestic financing rate • If Future spot rate < Forward Rate, lower effective financing rate • If Future spot rate > Forward Rate, higher effective financing rate (for uncovered forex position)
Exchange Rate Forecasts
• Firms may use exchange rate forecasts to forecast the effective financing rate of a foreign currency, or they may compute the break-even exchange rate that will equate the domestic and foreign financing rates. • Sometimes, it may be useful to develop probability distributions, instead of relying on single point estimates.
Exchange Rate Forecasts
• Sarasota Inc. needs funds for one year • Rate- US: 12% ; Swiss: 8% • Expected appreciation in CHF: 2 %
E(Rf ) = (1 + if ) [ 1+ E(ef) ]- 1 = (1.08)(1.02)- 1 = 0.1016 i.e. 10.16% Breakeven ef = 3.703% (for US rate and Swiss effective rate to be equal)
Exchange Rate Forecasts
• Use of Probability Distributions
Change in CHF Value Effective Financing Rate Probability -6% 0.0152 5% -4% 0.0368 10% -1% 0.0692 15% 1% 0.0908 20% 4% 0.1232 20% 6% 0.1448 15% 8% 0.1664 10% 10% 0.188 5% 0.10538
Expected Rate ?
Financing with a Portfolio of Currencies
• While foreign financing can result in significantly lower financing costs, the variance in the costs is higher. • MNCs may be able to achieve lower financing costs without excessive risk by financing with a portfolio of currencies. • If the chosen currencies are not highly positively correlated, they will not be likely to experience a high level of appreciation simultaneously.
Financing with a Portfolio of Currencies (contd.)
• Thus, the chances that the portfolio’s effective financing rate will exceed the domestic financing rate are reduced. • A firm that repeatedly finances in a currency portfolio will normally prefer to compose a financing package that exhibits a somewhat predictable effective financing rate on a periodic basis. • When comparing different financing packages, the variance can be used to measure how volatile a portfolio’s effective financing rate is.
Financing with a Portfolio of Currencies
For a two-currency portfolio,
E(rP) = wAE(rA) + wBE(rB)
where rP = the effective financing rate of the portfolio rX = the effective financing rate of currency X wX = the % of total funds financed from currency X
Financing with a Portfolio of Currencies
Var(rP) = wA2?A2 + wB2?B2 + 2wAwB?A?BCORRAB
For a two-currency portfolio, ?X2 = the variance of currency X’s effective financing rate CORRAB = the correlation coefficient of the two currencies’ effective finance rates
doc_690098248.ppt