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Unformatted text preview: Chapter 18 Long-Term Financing Lecture Outline Long-Term Financing Decision Sources of Equity Sources of Debt Cost of Debt Financing Measuring the Cost of Financing Actual Effects of Exchange Rate Movements on Financing Costs Assessing the Exchange Rate Risk of Debt Financing Use of Exchange Rate Probabilities Use of Simulation Reducing Exchange Rate Risk Offsetting Cash Inflows Forward Contracts Currency Swaps Parallel Loans Diversifying Among Currencies Interest Rate Risk from Debt Financing The Debt Maturity Decision The Fixed Versus Floating-rate Decision Hedging With Interest Rate Swaps Plain Vanilla Swap 32 33 International Financial Management Chapter Theme This chapter introduces the long-term sources of funds available to MNCs. Should the MNC choose bonds as a medium to attract long-term funds, a currency for denomination must be chosen. This is a critical decision for the MNC. While there is no clear-cut solution, this chapter illustrates how such a problem can be analyzed. A suggested method of presenting this analysis is to run through an example under assumed exchange rates. Then stress that future exchange rates are not known with certainty. Therefore, the firm should consider the possible costs of financing under a variety of exchange rate scenarios. Topics to Stimulate Class Discussion 1. Why would U.S. firms consider issuing bonds denominated in a foreign currency? 2. What are the desirable characteristics related to a currency’s interest rate (high or low) and value (strong or weak) that would make the currency attractive from a borrower’s perspective? POINT/COUNTER-POINT: Will Currency Swaps Result in Low Financing Costs? POINT: Yes. Currency swaps have created greater participation by firms that need to exchange their currencies in the future. Thus, firms that finance in a low interest rate currency can more easily establish an agreement to obtain the currency that has the low interest rate. COUNTER-POINT: No. Currency swaps will establish an exchange rate that is based on market forces. If a forward rate exists for a future period, the swap rate should be somewhat similar to the forward rate. If it was not as attractive as the forward rate, the participants would use the forward market instead. If a forward market does not exist for the currency, the swap rate should still reflect market forces. The exchange rate at which a low-interest currency could be purchased will be higher than the prevailing spot rate, since otherwise MNCs would borrow the low-interest currency and simultaneously purchase the currency forward so that they could hedge their future interest payments. WHO IS CORRECT? Use InfoTrac or some other search engine to learn more about this issue. Which argument do you support? Offer your own opinion on this issue....
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