Long-Term Financing 21 Lecture

Chapter Objectives To explain why MNCs consider long-term financing in foreign currencies; To explain how the feasibility of long-term financing in foreign currencies can be assessed; and To explain how the assessment of long- term financing in foreign currencies can be adjusted for bonds with floating interest rates.

Long-Term Financing Decision Since MNCs commonly invest in long-term projects, they rely heavily on long-term financing. Once the capital structure decision has been made, the MNC must consider the possible sources of equity or debt, and the costs and risks associated with each source.

Sources of equity and debt:  domestic offering in local currency  global offering in multiple currencies  private placement to home country financial institutions  private placement to host country financial institutions Many MNCs obtain equity funding in their home country, and engage in debt financing in foreign countries. Long-Term Financing Decision

Cost of Debt Financing The cost of debt financing depends on the quoted interest rate and the changes in the exchange rate of the borrowed currency over the life of the loan. To estimate the cost, an MNC needs to:  determine the amount of funds needed,  forecast the issue price of the bond, and  forecast the exchange rates for the times when it has to pay the bondholders.

Annualized Bond Yields Across Countries

Financing with Bonds Denominated in Dollars versus Singapore Dollars Piedmont Co. needs to borrow $1 million over a three-year period.

Cost of Debt Financing If the borrowed currency appreciates over time, an M NC will need more funds to cover the coupon or principal payments.  The potential savings from issuing lower- yield bonds denominated in a foreign currency should be weighed against the potential risk of incurring high costs if the borrowed currency appreciates over time.

Exchange Rate Effects on Payments for S$ Bond S$ weakens: S$ strengthens:

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

Exchange Rate Risk of Debt Financing When issuing bonds in a foreign currency, the exchange rate is very important. However, a point estimate does not account for forecast uncertainty. Hence, a probability distribution of the exchange rate should be developed and used to compute the expected financing cost and its probability distribution.

Exchange Rate Risk of Debt Financing The exchange rate probability distribution can also be fed into a computer simulation program to generate the probability distribution of the financing cost.

Source: Adopted from South- Western/Thomson Learning © 2006