C H A P T E R 18 Long-Term Financing

Chapter Overview A. Long-Term Financing Decision B. Cost of Debt Financing C. Assessing the Exchange Rate Risk of Debt Financing D. Reducing Exchange Rate Risk E. Interest Rate Risk from Debt Financing

Chapter 18 Objectives This chapter will: A. Explain why MNCs consider long-term financing in foreign currencies B. Explain how to assess the feasibility of long-term financing in foreign currencies C. Explain how the assessment of long-term financing in foreign currencies is adjusted for bonds with floating interest rates

A. Long-Term Financing Decision 1. Sources of Equity a. Offering in Home Country b. Global equity offering c. Private Placement of Equity to Financial Institutions in Home Country d. Private Placement of Equity to Financial Institutions in Foreign Country

B. Cost of Debt Financing 1. Measuring the Cost of Financing a. The MNC decides based on 1.) amount of funds needed 2.) forecast of bond price 3.) forecast of periodic exchange rate

B. Cost of Debt Financing a. Impact of a Strong Currency on Financing Costs 1.) If the currency that was borrowed appreciates over time, an MNC will need more funds to cover the coupon or principal payments. 2.) This type of exchange rate movement increases the MNC’s financing costs.

B. Cost of Debt Financing b. Impact of a Weak Currency on Financing Costs 1.) Whereas an appreciating currency increases the periodic outflow payments of the bond issuer, 2.) a depreciating currency will reduce the issuer’s outflow payments and 3.) reduce its financing costs.

B. Cost of Debt Financing 2. Actual Effects of Exchange Rate Movements on Financing Costs

Annualized Bond Yields among Countries 18.1

C. Assessing the Exchange Rate Risk of Debt Financing 1. Use of Exchange Rate Probabilities a. One approach to using point estimates of future exchange rates is to develop a probability distribution for an exchange rate for each period in which payments will be made to bondholders.

C. Assessing the Exchange Rate Risk of Debt Financing b. The expected value of the exchange rate can be computed for each period by multiplying each possible exchange rate by its associated probability and totaling the products. c. the exchange rate’s expected value can be used to forecast the cash outflows necessary to pay bondholders over each period.

18.6 Actual Costs of Annual Financing with Pound-Denominated Bonds from a U.S. Perspective 18.6

D. Reducing Exchange Rate Risk 1. Offsetting Cash Inflows a. Offsetting Cash Flows with High-Yield Debt 1.) Some firms may have inflow payments in particular currencies, which could offset their outflow payments related to bond financing 2.) a firm may be able to finance with bonds denominated in a foreign currency that exhibits a lower coupon rate without becoming exposed to exchange rate risk.

D. Reducing Exchange Rate Risk 2. Forward Contracts When a bond denominated in a foreign currency has a lower coupon rate than the firm’s home currency, the firm may consider issuing bonds denominated in that currency and simultaneously hedging its exchange rate risk through the forward market.

Illustration of a Currency Swap 18.7

D. Reducing Exchange Rate Risk 3. Currency Swaps a. A currency swap enables firms to exchange currencies at periodic intervals b. Many MNCs simultaneously swap interest payments and currencies

D. Reducing Exchange Rate Risk 4. Parallel Loans a. Using Parallel Loans to Hedge Exchange Rate Risk for Foreign Projects 5. Diversifying among Currencies

E. Interest Rate Risk from Debt Financing 1. The Debt Maturity Decision 2. The Fixed versus Floating Rate Decisions 3. Hedging with Interest Rate Swaps

E. Interest Rate Risk from Debt Financing 4. Plain Vanilla Swap a. Determining Swap Payments b. Other Types of Interest Rate Swaps c. Standardization of the Swap Market

Illustration of an Interest Rate Swap 18.10