Raising Capital

INTERNATIOANL FINACIAL MANAGEMENT Click to edit Master subtitle style

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Financing Global Business

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Financing Global Business

Sources of financing global operations

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Financing Global Business

Compared to financing international trade, the financing of global production is much more complex. These options include: Inter company Financing - where parent and sister subsidiaries finance one another Equity Financing Where financing is conducted through issuing stock in home or host country, or cross listing shares on multiple exchanges 7/7/12

Financing Global Business

Debt Financing

through Eurocurrency Markets, Eurocredits, or Euronotes. through international bonds (Eurobonds, foreign bonds, Global Bonds)

Local Currency Financing through bank loans, non-bank sources, discounting, and parallel loans
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INTERNATIONAL BONDS
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Domestic Bonds

Most countries have some system of financial regulation that applies to securities issued for sale to domestic investors Domestic bonds are issued in a country by a domestic issuer for domestic investors. They are denominated in that country's currency and are subject to that country's regulations.

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International Bond Market

International Bonds are bonds that are issued in a country by a nondomestic entity. International bond market is an attractive place to borrow money that fills an important niche in financing

Tends to be less expensive than local market bonds

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International bonds include Eurobonds, foreign bonds and global bonds.

Foreign Bonds
The Foreign Bond Market

A country's foreign bond market is that market in which the bonds of issuers not domiciled in that country are sold and traded. For example, the bonds of a German company issued in the U.S. or traded on the U.S. secondary markets would be part of the U.S. foreign bond market.

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The definition of "foreign" refers to the nationality of the issuer in relation to the market place. For example, a US dollar bond sold in the United States by the Swedish car producer Volvo is classified as a foreign bond while one issued by General Motors is a domestic bond.

Foreign Bonds
Features of the Foreign Bonds
1.

Foreign bonds are sold in the currency of the local economy. Foreign bonds are subject to the regulations governing all securities traded in the national market and sometimes special regulations governing foreign borrowers (e.g., additional registration).

1.

1.

Foreign bonds provide foreign companies access to funds they often 7/7/12 use to finance their operations in the

Foreign Bonds

Foreign bonds are regulated by the domestic market authorities The issuer must satisfy all regulations of the country in which it issues the bonds. The difference between a domestic and a foreign bond is that the issuer of the latter is a foreign entity which may be beyond investors' legal reach in the event of default. Since investors in foreign bonds are usually the residents of the domestic country, investors find them attractivebecause they can add foreign content to their portfolios without the added exchange rate exposure.

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Names of Foreign Bonds

Foreign bonds in the U.S. are called Yankee bonds. Foreign bonds in Japan are called Samurai bonds. Foreign bonds in Spain are called Matador bonds. Foreign bonds in the United Kingdom are called Bulldog bonds. Foreign bonds in the Netherlands are called Rembrandt bonds. 7/7/12

Eurobonds

A Eurobond is not a foreign bond issued within the European Union. Rather, it is a bond issued and traded within the mostly unregulated Euromarket. While that market originated within Europeand is still largely centered there it is a truly international market. Transactions are not subject to any particular nation's regulations. A Eurobond is a bond issued outside the country in whose currency it is denominated.

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A Eurodollar bond thatisdenominated in U.S. dollars and issued in Japan by an Australian company would be an example of a Eurobond. The Australian company in this example could

Eurobonds

Usually, aEurobond is underwritten by a multi-national syndicate of investment banks and simultaneously placed in many countries. For example, to raise funds to finance its European operations, a U.S. company might sell a bond denominated in British pounds throughout Europe. It is categorized according to the

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Eurobonds

Eurobonds are a very popular debt instruments. Volvo, Walt Disney, Nestle, and other multinational corporations finance many of their global operations by selling Eurobonds. Eurobonds are also a source of intermediate and long-term financing of sovereign governments and supranationals (e.g., World Bank and European Investment Bank).

European Investment Bank is the European Union's financing institution.

Russia, for example, raised $4B in 1997 7/7/12 through the sale of Eurobonds.

Eurobonds

Eurobonds are attractive financing tools as they give issuers the flexibility to choose the country in which tooffer their bond according to the country's regulatory constraints. They may also denominate their Eurobond in their preferred currency. Eurobonds are attractive to investors as they have small par values and high liquidity.

Currently, about 80% of new issues in the 7/7/12 international bond market are

Eurobond Market

The Eurobond market is handled through an international syndicate consisting of multinational banks, brokers, and dealers. A corporation or government wanting to issue a Eurobond will usually contact a multinational bank who will form a syndicate of other banks, dealers, and brokers from different countries. The members of the syndicate usually agree to underwrite a portion of the issue, which they usually sell to other banks, brokers, and dealers. Market makers handle the secondary market for Eurobonds. 7/7/12 Many of market makers are the same

Eurobond Market

An investor who wants to buy or sell an existing Eurobond can usually contact several market makers in the international OTC market to get several bid-ask quotes, before selecting the best one. While most secondary trading of Eurobonds occurs in the OTC market, many Eurobonds are listed on organized exchanges in Luxembourg, London, and Zurich. These listings are done primarily to accommodate investors from countries that prohibit (or once prohibited) institutional 7/7/12 investors from acquiring securities that are

Eurobond Features
1. Currency Denomination
The generic, plain vanilla Eurobond pays an annual fixed interest and has a longterm maturity. There are a number of different currencies in which Eurobonds are sold. The major currency denominations are the U.S. dollar, yen, and euro. (70 to 75 percent of Eurobonds are denominated in the U.S. dollar.) The central bank of a country can protect its currency from being used. Japan, for example, prohibited the yen from being used for Eurobond issues of its 7/7/12 corporations until 1984.

Eurobond Features 2. Non-Registered

Eurobonds are usually issued from countries in which there is little regulation. As a result, many Eurobonds are unregistered, issued as bearer bonds.

(Bearer form-unregistered, no record to identify the owners, usually kept on deposit at depository institution)

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While this feature provides confidentiality, it has created some problems in countries such as the U.S., where regulations require that security owners be registered on the books of issuer.

Eurobond Features
3. Credit Risk

Compared to domestic corporate bonds, Eurobonds have fewer protective covenants, making them an attractive financing instrument to corporations, but riskier to bond investors. Eurobonds differ in term of their default risk and are rated in terms of quality ratings.
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Eurobond Features 4. Maturities

The maturities on Eurobonds vary. Many have intermediate terms (2 to 10 years), referred to as Euronotes, and long terms (10-30 years), called Eurobonds. There is also short-term Europaper and Euro Medium-term notes.

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Eurobond Features
5. Other Features
1.

Like many securities issued today, Eurobonds often are sold with many innovative features. For example:

Dual-currency Eurobonds pay coupon interest in one currency and principal in another. Option currency Eurobond offers investors a choice of currency. For instance, a sterling/Canadian dollar bond gives the holder the right to receive interest and principal in either currency.

2.

A number of Eurobonds have special conversion features One type of convertible is a dualcurrency bond that allows the holder to convert 7/7/12 the bond into stock or another bond that is

Eurobond Features 5. Other Features

3.

A number of Eurobonds have special warrants attached to them. Some of the warrants sold with Eurobonds include those giving the holder the right to buy stock, additional bonds, currency, or gold. There are also floating-rate Eurobonds with the rates often tied to the LIBOR and floaters with the rate capped.

3.

3.

The Eurobond market has also issued zero discount bonds, and at one time, perpetual 7/7/12 Eurobonds with no maturities were issued; they,

Eurobond Features
EUROBONDS are issued by borrowers on the unregulated (or gently regulated) external capital markets. Usually, Eurobonds are:
v

issued in bearer form, (Bearer form-unregistered, no record to identify the owners, usually kept on deposit at depository institution) pay annual (as opposed to semiannual) coupons, Free of withholding tax - Interest must be paid free of withholding tax. Free of national regulation - Structured so that national authorities cannot control their issuance have call provisions. also carry convertibility clauses, or have

v v

and
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Growth of the Eurobond Market

From 1963 to 1984, the Eurobond market grew from a $7.5M market with a total of seven Eurobonds issues to an $80 billion market with issuers that included major corporations, supranationals, and governments. In 1984, the U.S. and Germany rescinded their withholding tax laws on foreign investments and a number of other countries followed their lead by eliminating or relaxing their tax codes. Even with this trend, though, the Eurobond market had already been established and would continue to remain a very active market, growing from an $80 billion market in new issue in 1984 to a $525 billion 7/7/12 market by 1990 and to a $1.4 trillion

Global bonds

Arbitrage between the foreign bond and Eurobond markets lead to the development of global bonds. These are bonds that blend characteristics of foreign bonds and Eurobonds and are issued in both markets simultaneously. A Global Bonds is both a foreign bond and a Eurobond. It is issued and traded as a foreign bond (being registered in a country) and also it is sold through a Eurobond syndicate as a Eurobond.

Unlike Eurobonds, global bonds can be issued in the same currency as the country of issuance. For example, a global bond could be both issued in the United States and 7/7/12 denominated in U.S. dollars.

Global bonds

The first global bond issued was a 10year, $1.5 billion bond sold by the World Bank in 1989. This bond was registered and sold in the U.S. (Yankee bond) and also in the Eurobond market. Currently, U.S. borrowers dominate the global bond market, with an increasing number of these borrowers being U.S. federal agencies. Global bonds are usually issued by entities that have high credit ratings The market has grown from a $30 billion market in the early 1990s to a $100 billion one in the late 1990s.

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Eurocurrencies
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Eurocurrency Market

A market in gently regulated time deposits

No withholding tax

No reserve requirements No interest regulation No deposit insurance

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Eurocurrency Market

The Eurocurrency market is the money market equivalent of the Eurobond market. Eurocurrency is any currency that is banked outside of its country of origin (Eurodollars are dollars banked outside the US) It is a market in which funds are intermediated (deposited or loaned) outside the country of the currency in which the funds are denominated.

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Example: A loan made in yens from a bank located in the U.S.

Current Eurocurrency Market

Currently, the Eurocurrency market consists of hundreds of banks, corporations, and governments. Commercial banks are the foundation of the market, offering various types of loans and deposits. Governments and companies use the market to deposit currencies, as well as obtain loans to finance assets, infrastructures, and even balance of payment deficits. Eurocurrency is a source of debt financing for multinationals beyond what they can find in their domestic market 7/7/12

Eurocurrency Market

Eurocurrency deposits and loans represent intermediation occurring in the Eurocurrency market. Even though the intermediation occurs in many cases outside Europe, the Euro prefix usually remains. An exception is the Asian dollar market. This market includes banks in Asia that accept deposits and make loans in foreign currency; this market is sometimes referred to separately as the Asian dollar market.

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Size of the Eurocurrency Market

Today the total amount of Eurocurrency deposits is estimated to be in excess of $2 trillion. The actual size of the market, though, is difficult to determine because of the lack of regulation and disclosure. By most accounts, though, it is one of the largest financial markets.
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The Nature of the Eurocurrency Market

The underlying reason for the existence of a Eurocurrency markets is that Eurocurrency loan and deposit rates are better than the rates on similar domestic loans and deposits because of the differences that exist in banking and security laws among countries.

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Interest Rate Spreads in Domestic and Eurocurrency Markets

Domes tic lending rate Domes tic deposi t rate Rate of intere st Eurocurr ency lending Eurocurr rate ency deposit rate

0 %

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Eurocurrency Market: Example

If the U.S.'s reserve requirement were 5% on time deposits for a certain size bank, while no requirements existed in the Bahamas, then a U.S. bank, by accepting a domestic deposit, could only loan out 95% of the deposit, earning 95% of the loan rate, in contrast to a Bahamian deposit in which 100% of the deposit could be loaned out to earn the full amount of the loan rate. In a competitive market for deposits and loans, the rates on the Bahamian loans and deposits would have to be made more favorable, since a depositor or borrower would prefer his own country. Thus, the absence of reserve requirements or regulations on rates paid on deposits in the Bahamas, 7/7/12 for example, makes it possible for the rates on

Current Eurocurrency Market

For large investors the market offers two types of instruments:

Eurocurrency CDs Primary Deposits

Eurocurrency CDs are denominated in currencies outside the currency's country. The maturities on Eurocurrency CDs range from one day to several years, with the most common maturities being 1, 3, 6 and 12 months.

The rates on the CDs are usually negotiated between the 7/7/12 investor/depositor and the bank and they

Current Eurocurrency Market

The rates frequently are quoted relative to the LIBOR. (Asian dollar CDs are quoted in terms of the Singapore Interbank Offer Rate (SIBOR)).

London Inter-Bank Offered Rate (LIBOR) interest rate that banks charge each other on Eurocurrency loans

Rates on Eurodollar CDs are typically higher than the rates on comparable domestic CDs. 7/7/12 Primary deposits are time deposits

Eurocurrency Market-sources of Funds Major sources:

Foreign governments or individuals Multinational corporations European banks Countries with large balance-of-trade surpluses

Germany Taiwan Japan

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Features of Eurocurrency Loans

The Eurocurrency market is an important funding source for corporations and governments. The loans to corporations and governments can be either short-term or intermediate, ranging in maturity from overnight to 10 years. The loans with maturities of over one year are called Eurocredits or Eurocredit loans.
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Since Euro deposits are short term,

Features of Eurocurrency Loans

Eurocurrency loans also vary is terms of some of their other features:

Loans can be either fixed or floating Loans can be in different currencies and have different currency clauses Many of the larger loans are provided by a syndicate of Eurobanks

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Characteristics of Eurocurrency market completely unregulated offshore market both short and medium term Eurocurrency deposits yield higher interest Eurocurrency loans tend to be cheaper Loans are made on a floating rate basis; six months rollover Many loans have Multicurrency clauses -borrower has the right to 7/7/12

Eurocurrencies and Eurobonds

Often confused with each other but there is a fundamental distinction:

In the Eurobond market, Eurobonds are directly issued by the final borrowers Eurocurrency market has commercial banks which holds deposits of investors and lends this money to the final borrowers.

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Foreign Equity Listing and Issuance

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Foreign Equity Listing and Issuance

In addition to issuing stock locally, multinationals can also obtain funds by issuing stock in international markets. This will enhance the firms image and name recognition, and diversify their shareholder base. A stock offering may also be more easily digested when it is issued in several markets.
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Foreign Equity Listing and Issuance

A firm must choose one or more stock markets on which to cross-list its shares and sell new equity. Just where to go depends mainly on the firms specific motives and the willingness of the host stock market to accept the firm. The locations of an multinationals operations can influence the decision about where to place its stock, in view of the cash flows needed to cover dividend payments. Market characteristics are important too. Stock markets may differ in size, trading activity level, and proportion of individual 7/7/12 versus institutional share ownership.

Cross-listing attempts to accomplish one or more of many objectives:

Foreign Equity Listing and Issuance

Improve the liquidity of its existing shares and support a liquid secondary market for new equity issues in foreign markets Increase its share price by overcoming mis-pricing in a segmented and illiquid home capital market Increase the firms visibility Establish a secondary market for shares used to acquire other firms Create a secondary market for shares that can be used to compensate local management and employees in foreign subsidiaries

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International Stock Markets

Stock issued in the U.S. by non-U.S. firms or governments are called Yankee stock offerings. Non-U.S. firms may also issue American depository receipts (ADRs), which are certificates representing bundles of stock. American depository receipts (ADRs) are certificates traded in the United States and denominated in US dollars.
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Mechanics of American Depositary Receipts (ADRs)

Shares
American Depositary Receipts issued by a bank representing underlying shares held by a custodial bank

Receipts (ADRs)

Publicly traded firm outside the U.S.

Receipts for shares listed on U.S. exchange

Traded by U.S. investors

Shares

Shares traded on local stock exchange

Arbitrag e Activity

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FINANCING FOREIGN PROJECTS

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Financing Foreign Projects

Financing

Internal

External

Debt

Equit y

Debt

Equit y
Home Currency Foreign Currency

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Home Currency

Foreign Currency

Internal Debt vs. Internal Equity The primary tradeoffs between internal debt
and internal equity center around taxes. If internal debt is used, interest payments made from the subsidiary to the parent are treated on a pre-tax basis in the host country. If internal equity is used, dividends repatriated from the subsidiary to the parent are treated on a post-tax basis. Generally, home country gives a tax-credit on foreign taxes paid on repatriated dividends of up to (but no more than) the home country tax bill on the dividends.

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Internal Debt vs. Internal Equity

MNCs using internal financing will have greater incentives to use debt: 1. The more volatile are parent earnings: higher probability of negative parent earnings means better chance interest payments will be untaxed. 2. The less volatile are subsidiary earnings: lower probability of negative subsidiary earnings means less chance subsidiary will be forced to make interest payments out of negative earnings that are taxed at the parent. 3. The larger the host country tax rate compared to the home country: larger host country tax rate 7/7/12 means larger potential tax shield.

External vs. Internal Financing

The tradeoffs between external and internal financing will be largely similar to those in a domestic context: - issuance costs - asymmetric information costs

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External Debt vs. External Equity - tax shields

- interest subsidies Additionally, the monitoring benefits debt may add over equity addressed in traditional finance settings will be applicable here.

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Home vs. Host Country Equity

From a political risk standpoint, issuing host country equity is likely to have two divergent effects:
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political risks (i.e. probability of expropriation) are likely to be reduced. political risks are likely to be more systematic to risks of host country shareholders portfolios.

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The Debt Denomination Decision If a firm borrows in domestic rather the

local currency, it faces greater exchange rate risk. The cost of financing in the local currency will consist (approximately) of the local currency interest rate premium and the expected exchange rate change.
The differential can be interpreted as the extent to which the firm accesses a homecurrency financing advantage in excess of anticipated exchange rate changes. This 7/7/12 will be traded-off against the larger

Key Points
1. Primary tradeoff of internal debt vs. equity is between the tax-shield benefit of debt and the flexibility of equity dividend repatriation. 2. Firms will tend to favor debt when parent earnings are volatile, subsidiary earnings are certain, and subsidiary tax rates are high. 3. With external financing, debt provides advantages over equity to the extent it offers tax shields, interest subsidies, and monitoring benefits.

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Key Points
4. When financing with external equity, firms will likely face higher equity costs of capital in the host country market. 5. Local equity will also often alter the magnitudes and pricing of political risks associated with the project. 6. In the debt denomination decision, an MNC which centralizes borrowing in home country is likely to get more-favorable rates.

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Key Points
7. MNCs which borrow in the currency of the project produce a natural hedge, offsetting project returns with debt obligations, and hence facing less exchange rate and political risk.

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