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International Financial Management - Currencies and Costs - Essay Example

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Inspite of the numerous opportunities of globalisation, multinational companies continue to face a number of risks with foreign exchange risk constituting an important component. Fluctuations in exchange rates can have significant impacts on the cash flows and profits of firms with foreign-currency-denominated assets and liabilities…
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International Financial Management - Currencies and Costs
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Download file to see previous pages That is, the probability of issuing foreign debt is highly correlated with the degree of foreign operations. Their results are consistent with those of Kedia and Mozumdar (2003), who conclude that firms have to satisfy a demand to hedge via foreign debt. Kedia and Mozumdar (2003), also conclude that the correlation between foreign operations and the probability of issuing foreign debt is consistent with both the role of foreign debt as a hedging instrument and the existence of information barriers.
The integration of capital markets implies that financial assets traded in different markets should possess the same risk/return characteristics. Kedia and Mozumdar (2003) however note that the segmentation of capital markets and barriers to international investment could result in opportunities for choosing the currency of debt to minimize funding costs (interest rates). Kedia and Mozumdar (2003) identify two sources of segmentation including legal barriers and Informational sources.
According to them legal barriers which constitute a broad variety of restrictions such as differences in tax treatment for foreign and domestic investments, capital controls, security law, and ownership restrictions could give rise to opportunities for multinational companies to reduce their funding rates. It is also evident in the study by Kedia and Mozumdar (2003) that foreign investors face high costs of gathering information about capital markets in different countries and as such domestic companies take advantage of this information asymmetry to issue debt at a low cost than they would have issued to domestic investors.
According to Keloharju and Niskanen (2001), issuing in the Euromarket may be more economical since it helps to mitigate withholding taxes and capital controls. They further illustrate that borrowing cost in two currencies can be reduced by borrowing the weaker currency and that tax laws in Finland encourage companies to borrow the foreign currency.
Allayannis et al (2003: pp 2669) in their study of the capital structure and financial risk of East Asian Firms with particular emphasis on foreign-currency debt use, provide evidence that differences in home country interest rates and foreign interest rates such as the London Interbank Offered Rate (LIBOR), are important determinants for both home country and foreign debt use. The study finds that the higher (lower) the difference in interest rates, the ...Download file to see next pagesRead More
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