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The MNC’s Capital Structure Decision

The MNC’s Capital Structure Decision

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The MNC’s
Capital Structure Decision

Corporate Characteristics
• Stability of cash flows. MNCs with more stable cash flows
can handle more debt.
• Credit risk. MNCs that have lower credit risk have more
access to credit.
• Access to retained earnings. Profitable MNCs and MNCs
with less growth may be able to finance most of their
investment with retained earnings.
• Guarantees on debt. If the parent backs the subsidiary’s
debt, the subsidiary may be able to borrow more.
• Agency problems. Host country shareholders may monitor
a subsidiary, though not from the parent’s perspective.
International Executive Master of Business Administration

The MNC’s
Capital Structure Decision

Country Characteristics
• Stock restrictions. MNCs in countries where investors have less
investment opportunities may be able to raise equity at a lower
cost.
• Interest rates. MNCs may be able to obtain loanable funds (debt)
at a lower cost in some countries.
• Strength of currencies. MNCs tend to borrow the host country
currency if they expect it to weaken, so as to reduce their
exposure to exchange rate risk.
• Country risk. If the host government is likely to block funds or
confiscate assets, the subsidiary may prefer debt financing.
• Tax laws. MNCs may use more local debt financing if the local tax
rates (corporate tax rate, withholding tax rate, etc.) are higher.
International Executive Master of Business Administration

Long Term Financing
252

Chapter 18

MNCs Tend to Match the Term of the
Project to the Term of the Financing
 Equity sources




Domestic equity offering
Global equity offering
Private placement of equity to a financial institution in the foreign country

 Debt sources


Similar set of options

 Stockholder vs. creditor conflict



Stockholder expect a higher rate of return and accept higher risk
Bondholder expect lower rate of return and accept lower risk.

Since Bonds in Some Countries Have Lower
Yields
• US firms have taken advantage of this by entering foreign

bond markets.
• The borrower must make payments in the foreign
currency – which imposes an additional risk that the
borrowed currency might appreciate over time.
• Therefore a MNC needs to determine the cost.
1.
2.
3.

Determine the amount of funds needed
Forecast the price to which it can issue the bond
Forecast the periodic exchange rate values

International Executive Master of Business Administration

Measure the Cost of Financing
Example:
MNC needs to borrow 1 million USD for 3 years.
• MNC believes that it can sell USD denominate bonds at
par value of 14%
• Option to borrow in Singapore dollars and convert to USD
• Then it would need to convert USD to Singapore dollars for

repayment - current exchange rate is .50USD to 1 Singapore

International Executive Master of Business Administration

Diversifying Among Currencies
• A MNC may denominate bonds in several currencies

rather than a single foreign currency so that any on
currency will not drastically increase the number of dollars
needed to cover financing payments.
• Issue bonds denominated in USD
• Issue bonds denominated in Japanese yen
• Issue bonds denominated in Canadian dollars

International Executive Master of Business Administration

Interest Rate Risk from Debt Financing
• Decision must be made on the maturity of the debt

instrument. Normally a maturity will not exceed the
expected life of the business in that country.
• Short maturity are exposed to interest rate risks. Forcing the MNC

to refinance at a higher rate.
• Long term instruments can not take advantage of interest rate
declines in the near future
• Fixed vs. floating rate decision. Interest can float in reference to

LIBOR (London interbank offer rate)
• Hedging with interest rate swaps. The exchange of fixed rate
payments for variable rate payments -

International Executive Master of Business Administration

Interest Rate Swaps

• A MNC with a high sensitivity to interest rate changes

seeks to reduce exposure.
• Interest rate swaps enable a firm to exchange fixed rate
payments for variable rate payments, and vice versa.
They are used by bond issuers to reconfigure future bond
payments to a more preferable structure
• A “Plain Vanilla” Swap is a standard contract without
unusual additions. Example:
• MNC A prefers to borrow a variable rate interest
• MNC B prefers to borrow a fixed rate interest
• Assume each MNC can borrow as follows:
• MNC A
9% fixed rate bond floating ½% + LIBOR
• MNCB
10 ½ % fixed rate bond floating 1% + LIBOR
• MNCA has an advantage in fixed rate and floating but more of an

advantage with floating
International Executive Master of Business Administration

International Corporate Finance

258

Plain Vanilla Swap

• MNC A should negotiate with MNC B to provide variable

rate payment Libor + ½ % in exchange for fixed rate
payments of 9 ½ %
Quality Company
Choice of 9% fixed
or LIBOR + .5%
Prefers variable

Fixed Rate
Payments
at 9%

Variable Rate
Payments at
LIBOR+.5%
Fixed Rate
Payments at
9.5%

Risky Company
Choice of 10.5% fixed
or LIBOR + 1%
Prefers fixed

Variable Rate
Payments at
LIBOR+1%

Investors in
Fixed Rate Bonds
Issued by
Quality Company

Investors in Variable
Rate Bonds Issued
by Risky Company

Gains ½ %

Saves ½ %

International Executive Master of Business Administration

Illustration of A Currency Swap
Euros Received From
Ongoing Operations
Euro
Payments

Dollars Received From
Ongoing Operations
Euro
Payments

Miller Company

[known within the dollardenominated market]
Dollar
Payments

Investors in Dollardenominated Bonds
Issued by Miller

Dollar
Payments
Beck Company

Dollar
Payments

[known within the eurodenominated market]
Euro
Payments

Investors in Eurodenominated Bonds
Issued by Beck

International Executive Master of Business Administration

Parallel Loans
Two MNC provide loans to each other subsidiary.
Hedges currency risk - parallel loans may
be a better choice than Forward or Futures
Contract. 
U.S. Parent

Subsidiary of
U.S.- based MNC
that is located
in the U.K.

Provision
of loans



Repayment
of loans in
the currency
that was
borrowed

British Parent

Subsidiary of
U.K.- based MNC
that is located
in the U.S.

International Executive Master of Business Administration