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Part III Foreign Exchange Risk Exposure and Management


									International Financing Markets

I. International Equity Sources
    - Global Equity Markets
    - Methods of Sourcing
           - Crosslisting in Secondary Markets
           - New Equity Issues
II. International Debt Sources
    - Debt Management and Funding Goals
    - International Debt Instruments
           - International Bank Loans
           - Euronotes
           - International Bond Market

Lecture 11                                       1
International Financing Sources
Classification of Global Financial Markets
               Internal Market                         External Market
              (National Market)                      International Market
                                                       Offshore Market

 Domestic Market           Foreign Market                   Euro-Equity

                                                       Euro-Bond Market
    Debt Market

                                                        Euro-Note Market
   Equity Market

             Characteristics of External Markets include:
                      International syndicate underwriters
                      Securities offered simultaneously in a number of countries
                      Issued outside jurisdiction of any one country

Lecture 11                                                                         2
I.           International Equity Sources

1. Global Equity Markets
   - Trends in International Equity Markets
         - Increase in size
             - Increased integration
             - Emerging markets of transition and developing economies
     - Differences among stock exchanges
            - use of specialists
             - trading mechanism: computerized vs trading floor
             - transaction costs (e.g. negotiable commissions vs fixed commissions)
             - listing requirements (e.g. more disclosure and strict accounting rules in U.S.)
     - Global Market Integration
           - close linkage of markets due to advances in telecommunication
           - increase in correlation of prices in different markets
           - firms achieve international pricing of securities

Lecture 11                                                                                       3
I.           International Equity Sources cont’d

 2. Methods of Sourcing Equity
 A. Crosslisting of shares on Foreign Stock Exchanges
       - in U.S., foreign shares are traded through ADRs

 •     American Depository Receipts (ADR): Negotiable certificates issued by a U.S
       bank to represent underlying shares of stock held in trust at a custodian bank
         – sold, transferred and registered like other stocks
         – can be exchanged for the underlying stock
         – sponsored vs unsponsored ADR
 •     Global Depository Receipts (GDR)

 Note: Firms do not raise capital in secondary markets. Why do then firms

     Lecture 11                                                                         4
I.           International Equity Sources cont’d

•    Motives for Cross listing
      – Improve liquidity of existing shares (benefits existing shareholders & increases the
        investor base)
      – To increase share price (through overcoming mis-pricing in segmented local market
          • Evidence: mixed
      – Increase firm visibility and political acceptance
      – To support a new equity issue in the foreign market
      – For acquisition of local firms (through a share offer)
      – To use shares for compensation of local management in the foreign affiliate
      – To mitigate possibility of hostile takeover

•    Barriers to Cross-listing
      – Implied increase in commitment to full disclosure and continuing investor relation
          • particularly important to firms listing in U.S. (stringent disclosure requirement)

Lecture 11                                                                                       5
I.           International Equity Sources cont’d

B. New Equity Issues
• Directed Share Issues:-
   share issues targeted at investors in a single country and underwritten by firms in
   that country
      – usually denominated in target country’s currency
      – public issue vs private placement
•    Euro-Equity Issue
     share issue to foreign investors in more than one market (in bearer form).
      – used by large firms with good credit rating and profitability.
      – recent issues associated with privatization of gov’t enterprises (e.g. British Telecom)
•    sale of foreign affiliate’s shares to investors of host country
•    sale of share to a foreign firm as part of a strategic alliance

Lecture 11                                                                                        6
II.          International Debt Sources

1. Debt Management and Funding Goals
• Maturing Matching
       – typically, finance current assets through current liabilities
       – long-term assets through long-term liabilities
•     Currency Matching
       – match currency denomination of assets and obligations
       – emphasize cash-flow based matching
•     Cost of Debt
       – comparison of debt sources should be based on effective cost basis
       – for foreign currency denominated debt, the effective cost equals after tax cost of
          repaying principal plus interest in firm’s home currency
       Example: U.S. multinational borrows DM3,000,000 for one year at 8% interest.
          Suppose DM appreciates from DM1.5/$ to DM1.20/$, and the tax rate is 34%. Find
          dollar cost of debt.
          Proceeds ($) = DM 3,000,000/ DM 1.5 = $2,000,000
          Repayment (DM) = DM 3 million X 1.08 = DM 3,240,000
          Repayment ($) = DM 3,240,000/ DM 1.2 = $ 2,700,000

Lecture 11                                                                                    7
II.          International Debt Sources cont’d

      Before-tax cost of debt (kd$) = {$2.7 M - $2 M}/ $2 M = 0.35 (35%)
      After-tax cost of debt = kd$ (1 - t) = 0.35 X 0.66 = 0.231

Generally, kdh = [(1+ kdf) X (1 + s )] - 1 , where s = % change in value of foreign currency
           (kd$) = [(1+0.08) (1 + 0.25)] - 1 = 0.231

2. International Debt Instruments
A. International Bank Loans (Euro Credits)
   - Sourced in Eurocurrency markets (Note: unbundling as a financial innovation)
         Eurocurrency: a time deposit of money in an international bank located in a country
      different from the country that issued the currency.
             * e.g. Eurodollar deposit - a U.S. dollar denominated bank-deposit outside the U.S.
      - issued by syndicate of banks and charges floating interest (based on LIBOR)
      - advantage includes: smaller spread between lending and borrowing rate
         Reasons: - no reserve requirements - high deposit rate
                   - wholesale market - low lending rate
                   - low risk borrowers - low lending rate

Lecture 11                                                                                    8
II.          International Debt Sources cont’d

B. The Euro-note market
   Euro-notes: short-term unsecured promissory notes issued by corporations and
   governments, and underwritten by a group of int’l inv’t and commercial banks
       – matures in 3 - 6 months, and costs less in interest expense than Eurocredits

      Euro-commercial Paper: unsecured short-term promissory note by a
      corporation or a bank and placed directly with the investment public through a
       – like euronotes, sold at discount from face value
            • e.g. sold a $1000 face value 90-day ECP priced to yield 8% per annum.
               Determine the proceeds
              Proceeds + Proceeds [ y/100 X N/360] = face value
              Proceeds = $1000 / [ 1 + [90/360 X 8/100]] = $980.39
      Euro-Medium Term Notes: fixed rate notes issued by a corporation with
      maturities ranging from less than a year to about 10 years.
            - coupon paying note and is priced like a bond
Lecture 11                                                                              9
II.          International Debt Sources cont’d

C. The International Bond Market
   Categories of International Bonds:
     Foreign Bonds: offered by a foreign borrower to investors in a national
                   capital market and denominated in that nation’s currency
             e.g. a German MNC issuing $-denominated bond to U.S investors (Yankee bond)
       Eurobond: denominated in a particular currency but sold to investors in
          national capital markets other than the country that issued the
          denominating currency.
          e.g. a Dutch borrower issuing DM-denominated bond to investors in U.K,
               Switzerland and Netherlands.
      – Bearer bond (vs registered bond) - in U.S. Yankee bonds and domestic bonds should
        be registered
      – Advantages of Eurobonds to the issuer include
          • less stringent regulation (foreign bonds regulated as domestic bonds)
          • lower cost of servicing (no withholding taxes, value of anonymity to investor)

Lecture 11                                                                                 10
II.          International Debt Sources cont’d

Types of International Bonds:
• Straight Fixed Rate Bond
       – fixed coupon, set maturity and full principal repayment
       – Pricing: Price = PV of coupon + PV of principal
       – may include option features: callable bond, puttable bond
•     Floating Rate Notes
       – variable coupon (based on a reference rate, e.g. LIBOR)
       – less sensitive to interest rate change compared to straight bond
•     Equity Related Bonds
       – Convertible Bond - provide right to exchange bond to a predetermined # of equity
         shares of the issuer
       – Bonds with equity warrants - straight bond + a call option on equity
•     Zero-Coupon Bond
       – does not pay coupon interest and sold at discount from face value
•     Dual Currency Bond
       – proceeds and coupon in one currency and repayment in another currency
•     Currency Cocktail Bond
       – denominated in a currency basket such as ECUs, instead of a single currency

Lecture 11                                                                                  11

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