Global Financing Decision

Dr HK Pradhan
XLRI Jamshedpur
 Long-Term Financing

A. Explain how exchange rate movements affect the

cost of long-term financing in foreign currencies

B. Explain how to reduce the exchange rate risk

associated with debt financing in foreign currencies

C. Explain the exposure and hedging of interest rate

risk due to debt financing

2
 CASE: CHASE SYNDICATED COMMERCIAL LOAN PROPOSAL(1996)

Chase Manhattan Asia Limited submits an indicative proposal to TISCO for a seven year FX
Term Loan Facility. Provided below is a summary of terms and conditions for consideration:

Borrower : The Tata Iron & Steel Co. Ltd.

Facility Type : Commercial Loan Facility
Purpose : To finance the commercial portion of financing for
the importation of plant and equipment.
Facility Amount : US$100,000,000.
Tenor : 7 years
Repayment : Bullet
Interest Margin : LIBOR + 100bps (6 Monthly payments)
Arrangement Fee : 100bps flat on the Facility Amount (US$ 100 Mn)
Security : First priority charge over assets purchased by the
proceeds of the Facility.
Financial Covenants : As applicable
Documentation : Standard provisions for such type of facility
including but not limited to negative pledge, pari
passu, cross default, representations and warranties,
material adverse change, events of default and etc.
Arranger : Chase Manhattan Asia Ltd.
Participating Banks : Member banks of the Syndicate
 IRR-valuation & Sensitivity Analysis

• Set the net dollar proceeds from the loan

• Set the expected LIBOR from the term structure
• Annualize all other fees and spread
• Set the expected depreciation of the home currency vis-à-
vis USD
• Use forward rates, if available, to compute home currency
cash flows
• Compute IRR of the cash flows under each LIBOR & USD-
INR Scenario
• Determine the most appropriate LIBOR-USD-INR
Combination rate over the time horizon
• Select the loan if the resultant IRR meets the company’s
financing criteria
• Compare with home currency loan rate for the period
 Long-Term Debt Financing Decision

Sources of Debt
a. Debt issuance in own country
b. Global debt offering (loans, bonds,
convertibles)

3
 Cost of Debt Financing

To make long-term financing in foreign currency,

the Company must decide the following
1. Determine the amount of funds needed
2. Forecast the costs at which it can raise
financing
3. Forecast periodic exchange rate values for the
currency denominating the loan & its interest
rates

4
 Measuring the Cost of Financing

1. Impact of a strong currency on financing

costs: if the currency that was borrowed
appreciates over time, an MNC will need
more funds to cover the coupon or principal
payments.
2. Impact of a weak currency on financing
costs: a depreciating currency will reduce the
issuer’s outflow payments and reduce
financing costs.
5
 Uncertainty of Financing Costs

1. Accounting for Uncertainty of Financing Costs by:

a. Sensitivity Analysis: develop alternative forecasts
for exchange rates each period and re-estimate
cost of financing.
b. Simulation: develop a probability distribution for
the exchange rate in each period and use a
computer simulation program to iterate possible
future scenarios.
2. Actual Financing Costs
a. Determine how exchange rate movements
affected the costs of loans denominated in a
6 foreign currency.
 Reducing Exchange Rate Risk

1. Offsetting cash inflows

a. Offsetting cash flows with cash outflows
2. Forward contracts
3. Currency swaps
4. Interest rate swaps
5. Parallel loans
a. Using parallel loans to hedge risk
6. Diversifying among currencies

7
 Reducing Interest Rate Risk

1. The debt maturity decision: interest rates

and the vary across maturities and across
countries.
2. Yield curve can be upward sloping, flat, or
inverted in different countries.
3. The fixed versus floating decision: floating
rate coupons can be tied to the London
Interbank Offer Rate (LIBOR)

11