IFM_IM_ch20 - Chapter 20 Short-Term Financing Lecture...

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Chapter 20 Short-Term Financing Lecture Outline Sources of Short-Term Financing Short-Term Notes Commercial Paper Bank Loans Internal Financing by MNCs Why MNCs Consider Foreign Financing Foreign Financing to Offset Foreign Currency Inflows Foreign Financing to Reduce Costs Determining the Effective Financing Rate Criteria Considered for Foreign Financing Interest Rate Parity The Forward Rate as a Forecast Exchange Rate Forecasts Actual Results from Foreign Financing Financing with a Portfolio of Currencies Portfolio Diversification Effects Repeated Financing with a Currency Portfolio 82
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Chapter 20: Short-Term Financing 83 Chapter Theme This chapter explains short-term liability management of MNCs. From this chapter, students should learn that correct financing decisions can reduce the firm’s costs. While foreign financing costs cannot usually be perfectly forecasted, firms should evaluate the probability of reducing costs through foreign financing. Topics to Stimulate 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. 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 (as opposed to borrowing all funds from one of these foreign currencies)? Explain. POINT/COUNTER-POINT: Do MNCs Increase Their Risk When Borrowing Foreign Currencies? POINT: Yes. MNCs should borrow the currency that matches their cash inflows. If they borrow a foreign currency to finance business in a different currency, they are essentially speculating on the future exchange rate movements. The results of their strategy are uncertain, which represents risk to the MNC and its shareholders. COUNTER-POINT: No. If MNCs expect that they can reduce the effective financing rate by borrowing a foreign currency, they should consider borrowing that currency. This enables them to achieve lower costs, and improves their ability to compete. If they take the most conservative approach by borrowing whatever currency matches their inflows, they may incur higher costs, and have a greater chance of failure. WHO IS CORRECT? Use the Internet to learn more about this issue. Which argument do you support? Offer your own opinion on this issue. ANSWER: If MNCs borrow in a low interest rate currency that is not matched with their inflow currencies, they may be able to reduce their effective financing rate. However, they increase their exposure to exchange rate risk. Their decision is based on a tradeoff of expected reduction in financing expenses versus the risk that the currency their borrow appreciates against their inflow currencies. Answers to End of Chapter Questions
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This note was uploaded on 12/30/2010 for the course MBA FI565 taught by Professor Benard during the Spring '10 term at Keller Graduate School of Management.

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IFM_IM_ch20 - Chapter 20 Short-Term Financing Lecture...

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