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

Review of Revenue, Review of Revenue This activity will require you to acc...

Review of Revenue This activity will require you to access at least a portion of the federal budget as well as a state, local and an agency budget. This can be done online. Howeve

WACC, The cost of capital for a firm can differ from the cost of capital fo...

The cost of capital for a firm can differ from the cost of capital for each of its businesses. When a firm has multiple businesses, it is important to use the cost of capital appro

Briefly the automated clearing house different participants, Problem: (...

Problem: (a) The Automated Clearing House (ACH) is an electronic payment network used by individuals, businesses, financial institutions and government organisations. (i) Ou

Describe statistical control- product and services, This subject has a majo...

This subject has a major individual assignment consisting of a number of tasks (parts). The assignment has been designed with the aim of providing you a practical application case

Estimate the sufficient taxable income, L has business assets worth $8 mill...

L has business assets worth $8 million and NOL carryovers of $1 million expiring in 14 years and of $2 million expiring in 15 years. 100% of L's stock is worth $10 million. The l

Banks, discuss in detail various sources ffom wherebabks can borrow funds w...

discuss in detail various sources ffom wherebabks can borrow funds within India

Competitive and efficient., Assume that there are two firms, firm A and fir...

Assume that there are two firms, firm A and firm B. The firms have identical present values at £10,000 and an identical future value profile as given in the picture below. The prob

Capital budgeting and the cost of capital, Roman Roads has a number of capi...

Roman Roads has a number of capital projects available for investment this year but has access to a limited amount of capital.  Specifically, the firm has arranged to secure a $25

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

Chapter 9 solution, Ask question #solution of question to discuss 4

Ask question #solution of question to discuss 4

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