Long-Term FinancingLong-Term Financing

2121 Lecture Lecture

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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.

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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.

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• 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

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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.

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Annualized Bond Yields Across Countries

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Financing with Bonds Denominated inDollars versus Singapore Dollars

• Piedmont Co. needs to borrow $1 million over a three-year period.

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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.

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Exchange Rate Effects on Payments for S$ Bond

S$ weakens:

S$ strengthens:

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

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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.

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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.

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