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FINANCING OPTIONS
The following are the options available to finance the MNCs. (1) The inter-company, (2) The local currency loan, and (3) Euro notes and Euro-commercial paper.
Inter-company Financing
This is the most common short term financing system among the MNCs. Here under this system, either the parent company or sister affiliate provide an inter- company loan. At times, however, these loans may be limited in amount or duration by official exchange, controls, etc. In addition, interest rates on inter-company loans are frequently required to fall within set limits. Normally, the lender‘s government will want the interest rate on an inter- company loan to be se as high as possible for both tax an balance-of-payments purposes, while the borrower‘s government will demand a low interest rate for similar reasons.
Local Currency Financing
This is another common system of financing the MNCs. Like the domestic firms, subsidiaries of multinational Companiesgenerally attempt to finance their working capital requirements locally, for both convenience and exposure management purposes. Since all industrial nations have well-developed commercial banking systems, firms desiring local financinggenerally turn there first. The major forms of bank financing include overdrafts, discounting, and term loans. Non-bank sources of funds include commercial paper and factoring.
Bank Loans
Loans from commercial banks are the dominant form of short-term interest- bearing financing used around the world. These loans are described as self-liquidating because they are usually used to finance temporary increases in accounts receivable and inventory. These increases in working capital are soon converted into cash, which is used to repay the loan. Short-term bank credits are typically unsecured. The borrower signs a note evidencing its obligation to repay the loan when it is due, along with accrued interest. Most notes are payable 90 days; the loan must, therefore, be repaid or renewed every 90 days. The need to periodically roll over bank loans gives substantial control over the use of its funds, credits are not being used for permanent financing, a bank will usually insert a cleanup clause requiring the company to be completely out of debt to the bank for a period of at least 30 days during the year.
Forms of Bank Credit
Banks credit provides a highly flexible form of financing because it is readily expandable and, therefore, serves as financial reserve. Whenever the firms needs extra short-term funds that can‘t be met by trade credit, it is likely to turn first to bank credit. Unsecured bank loans may be extended under a line of credits, under a revolving-credit arrangement, or on a transaction basis, Bank loans can be originated either in the domestic or Eurodollar market.
1. Term loans: Terms loans are straight loans, often unsecured, that are made for a fixed period of time, usually 90 days. They are attractive because they give corporate treasurers complete control over the timing of repayments. A term loan is typically made for a specific purpose with specific conditions and is repaid in a single lump sum. The loan provisions are contained in the promissory note that is signed by the customer. This type of loan is used most often by the borrowers who have an infrequent need for bank credit.
2. Line of Credit : Arranging separate loans for frequent borrowers is a relatively expensive means of doing business. One way to reduce these transaction costs is to use a line of credit. This formal agreement permits the company to borrow up to a stated maximum amount from the bank. The firm can draw down its line of credit when it requires funds and pay back the loan balance when it has excess cash. Although the bank is not legally obligated to honour the line-of-credit agreement, it almost always does unless it or the firm encounters financial difficulties. A line of credit is usually good for one year, with renewals renegotiated every year. 3. Overdrafts: In countries other than the United States, banks tend to lend through overdrafts. An overdrafts is simply a line of credit against which drafts (checks) can be drawn (written) upto a specified maximum amount. These overdraft lines are often extended and expanded year after year, thus providing in effect, a form of medium- term financing. The borrower pays interests on the debit balance only.
the stated maximum. The firm pays interest on its outstanding borrowings plus a commitment fee, ranging between 0.125% and 0.5% per annum, on the unused portion of the credit line. Revolving credit agreements are usually renegotiated every two or three years. The danger that short-term credits are being used to fund long-term requirements is particularly acute with a revolving credits line that is continuously renewed; Inserting an out-of-debt period under a cleanup clause validates the temporary need for funds.
5. Discounting. The discounting of trade bills is the preferred short-term financing technique in many European countries—especially in France, Italy, Belgium and to a lesser extent, Germany. It is also widespread in Latin America, particularly in Argentina, Brazil, and Mexico. These bills often can be rediscounted with the central bank. Discounting usually results from the following set of transactions. A manufacturer seller goods to a retailers on credit draws a bill on the buyer, payable in, say, 30 days. The buyer endorses (accepts) the bill or gets his or her bank to accept it, at which point it becomes a banker’s acceptance. The manufacturer then takes the bill to his or her bank, and the bank accepts it for a fee if the buyer‘s bank has not already accepted it. The bill is then sold at a discount to the manufacturer‘s banks or to a money maker dealer. The rate of interest varies with the term of the bill and the general level of local money market interest rates. The popularity of discounting in European countries steams from the fact that according to European commercial law, which is based on the Code Napoleon, the claim of the bill holder is independent of the claim represented by the underlying transaction.
Interest Rates on Bank Loans
The interest rate on bank loans is based on personal negotiation between the banker and the borrower. The loan rate charged to a specific customer reflects that customer‘s creditworthiness, previous relationship with the bank, the maturity of the
loan, and other factors. Ultimately, of course, bank interest rates are based on the same factors as the interest
Another cost associated with issuing commercial paper is fees paid to the large commercial banks that acts as issuing and paying agents for the paper issuers and handle all
the associated paper work. Finally rating services charge fees ranging from $5,000 to $25,000 per year for rating, depending on the rating service. Credit ratings are not legally required by any nation, but they are often essential for placing paper.
Euro notes and Euro-Commercial Paper
A recent innovation in non-bank short-term credits that bears a strong resemblance to commercial paper is the so-called Euro note. Euro notes are short- term notes usually denominated in dollars and issued by Companies and governments. The prefix ―Euro‖ indicates that the notes are issued outside the country in whose currency they are denominated. The interest rates are adjusted each time the notes are rolled over. Euro notes are often called Euro-commercial paper (Euro-CP, for short). Typically, though, the same Euro-CP is reserved for those Euro notes that are not underwritten.
There are some differences between the U.S. commercial paper and the Euro-CP markets. For one thing, the averagematurity of Euro-CP is about twice as long as the average maturity of U.S. CP. Also, Euro-CP is actively traded in a secondary market, but most U.S. CP is held to maturity by the original investors. Central banks, commercial banks, andCompanies are important parts of the investor base for particular segments of the Euro-CP market; the most important holders of U.S. CP are money market funds, which are not very important in the Euro -CP market. In addition, thedistribution of U.S. issuers in the Euro-CP market is of significantly lower quality that the distribution of U.S. issuers in the U.S.-CP market. An explanation of this finding may lie in the importance of banks as buyers of less-than-prime paper inthe Euro-CP market.
CALCULATING THE ALTERNATIVE FINANCING
OPTIONS
Alternative Financing Options gives the formulas to compute the effective dollar costs of a local currency loan and a dollar loan for both the no-tax and tax cases. These cost formulas can be used to calculate the least expensive financing source for each future exchange rate. This can be calculated through break-even analysis and determine the range of future exchange rates within which each particular financing option is cheapest. The Logic of this break-even analysis can be extended to financing alternatives. In all situations, the cost of each source of funds
FINANCING FOREIGN TRADE
Foreign Trade is the main business of the traders of ever country. Almost all the MNCs are heavily involved of foreigntrade in addition to their other international activities. So they require finance for all activities re lated to the trade, working capital, and other services namely letter of credit and acceptances. Hence, the people who are responsible for themanagement of the MNCs must have the practical knowledge of the institutions and documentary procedures to facili tate the international movement of goods.
PAYMENT TERMS IN INTERNATIONAL TRADE
International Trade or Foreign Trade means the trade between the traders of the two countries with two different types of currencies. A strong constructive belief between them is absolutely essential in order to make the international trade successful. Finance is essential and needed in every step and every shipment., The exporter needs financing to buy or manufacture its goods. Similarly, the importer has to carry these goods in inventory until the goods are sold. Then, it must finance its customer‘s receivables. A financially strong exporter can finance the entire trade cycle out of its own funds by extending credit until the importer has converted these goods into cash. Alternatively, the importer can finance the entire cycle by paying cash in advance. According to Prof. Allen C Shapiro, by taking all factors the following five basic means of payments are in practice.
F 0A 7 Cash in advance F 0A 7 Letter of credit F 0A 7 Draft F 0A 7 Consignment F 0A 7 Open account
Cash in Advance
Cash in advance affords the exporter the greater protection because payment is received either before shipment or upon arrival of the goods. This method also allows the exporter to
permission of all parties concerned, including the exporter. Most credits between unrelated parties are irrevocable.
A letter of credit can also be confirmed or unconfirmed. A confirmed L/C is an L/C issued by one bank an confirmed by another, obligating both banks to honor any drafts drawn in compliance. An unconfirmed L/C is the obligation of only the issuing bank. Thus the three main types of L/C in order of safety for the exporter, are (1) the irrevocable, Confirmed L/C; (2) the irrevocable, unconfirmed L/C; and (3) the revocable L/C. A transferable L/C is one under which the beneficiary has the right to instruct the paying bank to make the credit available to one or more secondary beneficiaries No. L/C is transferable unless specifically authorized in the credit; moreover, it can be transferred only once. The stipulated documents are transferred along with the L/C.
The Draft
Commonly used in international trade, a draft is an unconditional order in writing— usually signed by the exporter (seller) and addressed to the importer (buyer) or the importer‘s agent—ordering the importer to pay on demand, or at a fixed or determinable future date, the amount specified on its face. Such as instrument, also known as a bill of exchange , serves three important functions:
F 0A 7 To provide written evidence, in clear and simple terms, of financial obligation. F 0A 7 To enable both parties to potentially reduce their costs of financing. F 0A 7 To provide a negotiable and unconditional instrument (that is, payment must be made to any holder in due course despite any disputes over the underlying commercial transaction.)
or correspondent bank), collects on the drafts, and then remits the proceeds to the exporters. The bank has all the necessary documents for control of the merchandise and turns them over to the importer only when the draft has been paid or accepted in accordance with the exporter‘s instructions. The conditions for a draft to be negotiable are that it must be: F 0A 7 In writing F 0A 7 Signed by the issuer (drawer) F 0A 7 An unconditional order to pay F 0A 7 A certain sum of money F 0A 7 Payable on demand or at a definite future time F 0A 7 Payable to order of bearer
There are usually three parties to draft. The party who signs and sends the draft to the second party is called the drawer; payment is made to the third party, the payee. Normally, the drawer and payee are the same person. The party to whom the draft is addressed is the drawee, who may be either the buyer or if a letter of credit was used, the buyer‘s bank. In case of confirmed L/C, the drawee would be the confirming bank.
Drafts may be either sight or time drafts. Sights drafts must be paid on presentation or else dishonored. Time drafts are payable at some specified future date and as such become a useful financing device. The maturity of a time draft is known as its usance or tenor. A s mentioned earlier to qualify as a negotiable instrument, the date of payment must be determinable.
A time draft becomes an acceptance after being accepted by the drawee. Accepting a draft means writing accepted across its face, followed by an authorized person‘s signature and the date. The party accepting a draft incurs the obligation to
pay it at maturity. A draft accepted by a bank become a banker’s acceptance; one drawn on and accepted by a commercial
Open Account
Open account selling is shipping goods first and billing the importer later. The credit terms are arranged between the buyer and seller, but the seller has little evidence of the importer‘s obligation to pay a certain amount at a certain date. Sales on open account, therefore, are made only to a foreign affiliate or to a customer with which the exporter has a long history of favorable business dealings. However, open accounts sales have greatly expanded due to the major increase in international trade, the improvement in credit information about importers, and the greater familiarly with exporting in general. The benefits include greater flexibility (no specific payment dates are set) and involve lower costs, including fewer bank charges than with other methods of payment. As with shipping on consignment, the possibility of currency controls is an important factor because of the low priority in allocating foreign exchange normally accorded this type of transaction.
Banks and Trade Financing
Historically, banks have been involved in only a single step in international trade transactions such as providing a loan or aletter of credit. But as financing has become an integral part of many trade transactions, U.S, banks—especially major money center banks—have evolved as well. They have gone from financing individual trade deals to providingcomprehensive solutions to trade needs. This includes combining bank lending with subsidized funds from government export agencies, international leasing, and other non-bank financing sources, along with political and economic riskinsurance.
DOCUMENTS IN INTERNATIONAL TRADE
The important documents required in commercial bank financing of exports are Bill of Lading, Commercial Invoice, Consular invoice and Insurance Certificate. They are briefly discussed.
Bill of Lading
Of the shipping documents, the bill of lading (B/L) is the most important. It serves three main and separate functions:
