C H A P T E R 18

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C H A P T E R 18

• Long-Term Financing

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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

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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

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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

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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

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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 MNCs financing costs.

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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 issuers outflow payments and
• 3.) reduce its financing costs.

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B. Cost of Debt Financing

• 2. Actual Effects of Exchange Rate Movements on
  Financing Costs

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Annualized Bond Yields among Countries

• 18.1

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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.

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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 rates expected value can be
  used to forecast the cash outflows necessary to
  pay bondholders over each period.

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

• 18.6

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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.

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D. Reducing Exchange Rate Risk

• 2. Forward Contracts
• When a bond denominated in a foreign currency
  has a lower coupon rate than the firms home
  currency, the firm may consider issuing bonds
  denominated in that currency and
• simultaneously hedging its exchange rate risk
  through the forward market.

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Illustration of a Currency Swap

• 18.7

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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

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D. Reducing Exchange Rate Risk

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

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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

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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

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Illustration of an Interest Rate Swap

• 18.10