C H A P T E R 18 Long-Term Financing. Chapter Overview A. Long-Term Financing Decision B. Cost of...

C H A P T E R 18C H A P T E R 18

Long-Term FinancingLong-Term Financing

Chapter OverviewChapter Overview

A. Long-Term Financing DecisionA. Long-Term Financing Decision

B. Cost of Debt FinancingB. Cost of Debt Financing

C. Assessing the Exchange Rate Risk of C. Assessing the Exchange Rate Risk of Debt FinancingDebt Financing

D. Reducing Exchange Rate RiskD. Reducing Exchange Rate Risk

E. Interest Rate Risk from Debt Financing E. Interest Rate Risk from Debt Financing

Chapter 18 ObjectivesChapter 18 Objectives

This chapter will:This chapter will:

A. Explain why MNCs consider long-term A. Explain why MNCs consider long-term financing in foreign currenciesfinancing in foreign currencies

B. Explain how to assess the feasibility of B. Explain how to assess the feasibility of long-term financing in foreign currencieslong-term financing in foreign currencies

C. Explain how the assessment of long-term C. Explain how the assessment of long-term financing in foreign currencies is financing in foreign currencies is

adjusted adjusted for bonds with floating interest for bonds with floating interest rates rates

A. Long-Term Financing DecisionA. Long-Term Financing Decision

1. Sources of Equity1. Sources of Equity

a. Offering in Home Countrya. Offering in Home Country

b. Global equity offeringb. Global equity offering

c. Private Placement of Equity to c. Private Placement of Equity to

Financial Institutions in Home Financial Institutions in Home CountryCountry

d. Private Placement of Equity to d. Private Placement of Equity to

Financial Institutions in Foreign Financial Institutions in Foreign CountryCountry


1. Measuring the Cost of Financing1. Measuring the Cost of Financing

a. The MNC decides based ona. The MNC decides based on

1.) amount of funds needed1.) amount of funds needed

2.) forecast of bond price2.) forecast of bond price

3.) forecast of periodic 3.) forecast of periodic exchange rateexchange rate


a. Impact of a Strong Currency on Financing a. Impact of a Strong Currency on Financing Costs Costs

1.) If the currency that was borrowed 1.) If the currency that was borrowed appreciates over time, an MNC will appreciates over time, an MNC will need more funds to cover the coupon need more funds to cover the coupon or principal payments. or principal payments.

2.) This type of exchange rate movement 2.) This type of exchange rate movement increases the MNC’s financing costs.increases the MNC’s financing costs.


b. Impact of a Weak Currency on b. Impact of a Weak Currency on Financing Costs Financing Costs

1.) Whereas an appreciating 1.) Whereas an appreciating currency increases the currency increases the

periodic periodic outflow payments of outflow payments of the bond the bond issuer, issuer,

2.) a depreciating currency will 2.) a depreciating currency will reduce the issuer’s outflow reduce the issuer’s outflow payments and payments and

3.) reduce its financing costs.3.) reduce its financing costs.


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

18.118.1

Annualized Bond Yields among Countries

C. Assessing the Exchange Rate C. Assessing the Exchange Rate Risk of Debt FinancingRisk of Debt Financing

1. Use of Exchange Rate Probabilities1. Use of Exchange Rate Probabilities

a. a. One approach to using point One approach to using point estimates of future exchange rates is estimates of future exchange rates is to develop a probability to develop a probability distribution for distribution for an exchange rate for an exchange rate for each period in each period in which payments will which payments will bebe made to made to bondholders.bondholders.

C. Assessing the Exchange Rate C. Assessing the Exchange Rate Risk of Debt FinancingRisk of Debt Financing

b.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 rate’s expected value can

be used to forecast the cash outflows necessary to pay bondholders over each period.

18.618.6

Actual Costs of AnnualFinancing withPound-DenominatedBonds from a U.S. Perspective


1. Offsetting Cash Inflows1. Offsetting Cash Inflows a. Offsetting Cash Flows with High-Yield Debta. Offsetting Cash Flows with High-Yield Debt

1.) Some firms may have inflow payments in 1.) Some firms may have inflow payments in particular currencies, which could offset particular currencies, which could offset

their outflow payments related to bond their outflow payments related to bond financingfinancing

2.) 2.) a firm may be able to finance with bonds a firm may be able to finance with bonds denominated in a foreign currency that denominated in a foreign currency that

exhibits exhibits a lower coupon rate without becoming a lower coupon rate without becoming exposed exposed to exchange rate risk.to exchange rate risk.


2. Forward Contracts2. Forward ContractsWhen a bond denominated in a foreign currency has a lower coupon rate than the firm’s home currency, the firm may consider issuing bonds denominated in that currency and simultaneously hedging its exchange rate risk through the forward market.

18.718.7

Illustration of a Currency Swap


3. Currency Swaps3. Currency Swaps

a. A currency swap enables firms to a. A currency swap enables firms to exchange currencies at periodic exchange currencies at periodic intervalsintervals

b. b. Many MNCs simultaneously Many MNCs simultaneously swap swap interest payments and interest payments and currenciescurrencies


4. Parallel Loans4. Parallel Loansa. Using Parallel Loans to Hedge a. Using Parallel Loans to Hedge

Exchange Rate Risk for Foreign Exchange Rate Risk for Foreign ProjectsProjects

5. Diversifying among Currencies5. Diversifying among Currencies

E. Interest Rate Risk from Debt E. Interest Rate Risk from Debt FinancingFinancing

1. The Debt Maturity Decision1. The Debt Maturity Decision

2. The Fixed versus Floating Rate 2. The Fixed versus Floating Rate DecisionsDecisions

3. Hedging with Interest Rate Swaps3. Hedging with Interest Rate Swaps

E. Interest Rate Risk from Debt E. Interest Rate Risk from Debt FinancingFinancing

4. Plain Vanilla Swap4. Plain Vanilla Swap

a.a. Determining Swap PaymentsDetermining Swap Payments

b. b. Other Types of Interest Rate Other Types of Interest Rate SwapsSwaps

c. c. Standardization of the SwapStandardization of the SwapMarketMarket

18.1018.10

Illustration of an Interest Rate Swap

C H A P T E R 18 Long-Term Financing. Chapter Overview A. Long-Term Financing Decision B. Cost of...

Documents

Transcript of C H A P T E R 18 Long-Term Financing. Chapter Overview A. Long-Term Financing Decision B. Cost of...