Mncs do increase their risk by borrowing foreign currencies, Corporate Finance

Assignment Help:

According to those who are in favor of borrowing, the MNCs can achieve lower financing costs and hence their competing ability is improved. But according to the international fisher effect, "the percentage change in the spot exchange rate of a currency in terms of another will, on average, equal to the differential of interest rates between the two countries". This is expressed in the below equation (Carey & Essayyad, 1990). 

Change in spot rate of foreign currency =

(1+ interest rate in the home country) – 1 /(1 + interest rate in the foreign country)

                Suppose a dollar debt can be obtained at 10% and a pound debt can be obtained at a cheaper 5%, according to the international fisher effect, the interest rate differences will be soon converted into appreciation on pound and depreciation on dollar, which implies that pounds are not cheap to borrow just because the interest rate on pound is lower comparatively. According to the international fisher effect, exchange rate in due course will balance the interest rate differentials.

Though international fisher effect has been proved to not work in reality by many, there are also evidences wherein it holds. For example, a study by Utami & Inanga (2009) has proved that international fisher effect holds for Indonesia. Hence this theory cannot be held aside. Hence the argument of those in favor of borrowing cannot hold when international fisher effect holds. The lower financing costs will be soon converted into exchange rate appreciation and depreciation, thus making both costs equal or at least approximately equal ultimately.

In addition, the international fisher effect has been known to hold at best in the long term compared to the short term. According to Bartram et al (2005), there is existence of foreign exchange rate risk because both PPP theory and international fisher effect holds in the long term much better. There are many other studies and research papers that prove the same as well. The foreign borrowing will be utilized especially by the MNCs for long term purposes. Hence it is again proved that the low cost of financing will be soon compensated through the changes in the respective exchange rates.

Thus the attractiveness of lower costs of financing will increase the foreign exposure of multinational companies, thus increasing their risk as well. With increased risk, the company would have to take precautionary measures such as hedging through various derivative instruments. This just increases the cost incurred by the firm and overall, with higher costs, the company's competitive ability is lowered in the global as well as domestic level thus leading to high failure chances for the business.       

 Thus I strongly believe that Multinational Corporations increase risk when borrowing foreign currencies. 


Related Discussions:- Mncs do increase their risk by borrowing foreign currencies

What is phoenix activity, Q. What is phoenix activity? Phoenix activity...

Q. What is phoenix activity? Phoenix activity is "the evasion of tax and other liabilities, such as employee entitlements, through the deliberate, systematic and sometimes cycl

High demand uncertainty, Fashion products in general are characterized by h...

Fashion products in general are characterized by high demand uncertainty, high stockout costs and a high risk of obsolescence (Lee, 2002). Although the speci?c mail order company t

Red lake mines, Red Lake Mines, Inc. is considering adoption of a new proje...

Red Lake Mines, Inc. is considering adoption of a new project requiring a net investment of $10 million. The project is expected to generate 5 years of net cash inflows of $5 milli

Sales and lost demand data, The total sales are not necessarily equal to to...

The total sales are not necessarily equal to total demand, since some demand may have been lost. For the case that lost demand is not recorded at all, Fisher et al. (2000) propose

Financial management, determine the pay \back period for the project.

determine the pay \back period for the project.

Find the expected return and standard deviation, Question: (a) You are...

Question: (a) You are given the following information on two risky assets A and B. E(X) = 25% E(Y) = 30% Var (X) = 16% Var (Y) = 49% The correlation matr

Homework Help, Look back to Section 13–1 (Table 13.2 on p. 329). Suppose th...

Look back to Section 13–1 (Table 13.2 on p. 329). Suppose that Ms. Macbeth’s investment bankers have informed her that since the new issue of debt is risky, debt holders will deman

Commercial insurance example, The East Coast Conglomerate Co (ECCC) a small...

The East Coast Conglomerate Co (ECCC) a small manufacturing company is doing a risk management assessment and a total review of their insurance policies. They have asked you,  know

Calculate the pv and npv, Suppose you take out a loan of $10,000, repayable...

Suppose you take out a loan of $10,000, repayable by five equal annual instalments. The interest rate is 10% per year. (a) How much do you need to repay per year to the nearest ce

RISK, Calculate arithmetic returns and risk-premium of stocks. Describe the...

Calculate arithmetic returns and risk-premium of stocks. Describe the stock market behavior. Calculate expected return, variance and standard deviation for individual stocks and po

Write Your Message!

Captcha
Free Assignment Quote

Assured A++ Grade

Get guaranteed satisfaction & time on delivery in every assignment order you paid with us! We ensure premium quality solution document along with free turntin report!

All rights reserved! Copyrights ©2019-2020 ExpertsMind IT Educational Pvt Ltd