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Short-Term Financing

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					S HORT -T ERM F INANCING
     S OURCES           OF    S HORT -T ERM
                                 F INANCING

   Euronotes are unsecured debt securities with
    typical maturities of 1, 3 or 6 months. They are
    underwritten by commercial banks.

   MNCs may also issue Euro-commercial papers to
    obtain short-term financing.

   MNCs utilize direct Eurobank loans to maintain a
    relationship with the banks too.
         I NTERNAL F INANCING BY
                           MNC S

   Before an MNC’s parent or subsidiary searches
    for outside funding, it should determine if any
    internal funds are available.

   Parents of MNCs may also raise funds by
    increasing their markups on the supplies that
    they send to their subsidiaries.
    W HY MNC S C ONSIDER
      F OREIGN F INANCING
   An MNC may finance in a foreign currency to
    offset a net receivables position in that foreign
    currency.

   An MNC may also consider borrowing foreign
    currencies when the interest rates on such
    currencies are attractive, so as to reduce the
    costs of financing.
          D ETERMINING THE
E FFECTIVE F INANCING R ATE
    The actual cost of financing depends on

     the interest rate on the loan, and

     the movement in the value of the borrowed
       currency over the life of the loan.
C RITERIA C ONSIDERED FOR
      F OREIGN F INANCING
    There are various criteria an MNC must consider
     in its financing decision, including
        interest rate parity,
        the forward rate as a forecast, and
        exchange rate forecasts.
C RITERIA C ONSIDERED FOR
      F OREIGN F INANCING
 Interest Rate Parity (IRP)

    If IRP holds, foreign financing with a
     simultaneous hedge of that position in the
     forward market will result in financing costs
     similar to those for domestic financing.
C RITERIA C ONSIDERED FOR
      F OREIGN F INANCING
 The Forward Rate as a Forecast

    If the forward rate is an unbiased predictor of the
     future spot rate, then the effective financing rate
     of a foreign loan will on average be equal to the
     domestic financing rate.
C RITERIA C ONSIDERED FOR
      F OREIGN F INANCING
 Exchange Rate Forecasts

    Firms may use exchange rate forecasts to
     forecast the effective financing rate of a foreign
     currency, or they may compute the break-even
     exchange rate that will equate the domestic and
     foreign financing rates.

    Sometimes, it may be useful to develop
     probability distributions, instead of relying on
     single point estimates.
                   A CTUAL R ESULTS
    F ROM       F OREIGN F INANCING

   The fact that some firms utilize foreign financing
    suggests that they believe reduced financing
    costs can be achieved.
        F INANCING WITH A
P ORTFOLIO OF C URRENCIES
      While foreign financing can result in significantly
       lower financing costs, the variance in the costs is
       higher.

      MNCs may be able to achieve lower financing
       costs without excessive risk by financing with a
       portfolio of currencies.
        F INANCING WITH A
P ORTFOLIO OF C URRENCIES
      If the chosen currencies are not highly positively
       correlated, they will not be likely to experience a
       high level of appreciation simultaneously.

      Thus, the chances that the portfolio’s effective
       financing rate will exceed the domestic financing
       rate are reduced.
        F INANCING WITH A
P ORTFOLIO OF C URRENCIES
      A firm that repeatedly finances in a currency
       portfolio will normally prefer to compose a
       financing package that exhibits a somewhat
       predictable effective financing rate on a periodic
       basis.

      When comparing different financing packages,
       the variance can be used to measure how volatile
       a portfolio’s effective financing rate is.
                F INANCING WITH A
        P ORTFOLIO OF C URRENCIES
For a two-currency portfolio,
             E(rP) = wAE(rA) + wBE(rB)
    where     rP = the effective financing rate of the portfolio
              rX = the effective financing rate of currency X
              wX = the % of total funds financed from currency X
               F INANCING WITH A
       P ORTFOLIO OF C URRENCIES
For a two-currency portfolio,
Var(rP) = wA2A2 + wB2B2 + 2wAwBABCORRAB
       X2    = the variance of currency X’s effective financing rate
     CORRAB   = the correlation coefficient of the two currencies’
                effective finance rates

				
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