Lecture International finance: An analytical approach (3/e): Chapter 15 - Imad A. Moosa

Chapter 15 - International long-term financing and investment. In this chapter, the learning objectives are: To describe international bank loan financing, to demonstrate how the currency denominating a bond issue is chosen, to describe the primary and secondary international equity markets,…

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Chapter 15

International Long-Term

Financing and Investment

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Objectives

• To describe international bank loan financing

• To demonstrate how the currency denominating a

bond issue is chosen

• To describe the primary and secondary international

equity markets

• To outline other means of international long-term

financing

(cont.

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PPTs t/a International Finance: An Analytical Approach 3e by Imad A Moosa

Slides prepared by Afaf Moosa

Objectives (cont.)

• To explain how choice is made between domestic

and foreign securities as investment outlets

• To consider the effect of taxation on the choice

between domestic and foreign portfolio investments

• To illustrate the effect of international portfolio

diversification

15-3

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International bank loans

• Foreign loans: raised by borrowers who are foreign

to the country where the loans are raised

• Euroloans: loans denominated in a currency other

than the currency of the country where the loans are raised

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Syndicated loans

• Syndicated loans (Euro or foreign) are so large that it becomes necessary to form a syndicate or a group

of lending banks to finance the loans The interest

charged is a reference rate plus a spread

15-5

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The spread

• The interest paid on syndicated loans is usually

calculated by adding a spread to the London

interbank offer rate (LIBOR) or another reference

rate such as the US prime rate or the Singapore

interbank offer rate (SIBOR)

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Determinants of the spread

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• Eurobonds are placed (sold) in countries other than the country in whose currency the issue is

denominated

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Foreign bonds

• Foreign bonds are issued by borrowers who are

foreign to the country where the bonds are placed

• The bonds are denominated in the country’s

currency

15-9

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Nicknames of foreign bonds

• Yankee bonds (United States)

• Samurai bonds (Japan)

• Bulldogs (United Kingdom)

• Matilda bonds (Australia)

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Reasons for the emergence of the Eurobond market

• Absence of regulatory interference

• Less stringent disclosure requirements

• Favourable tax status

15-11

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Types of international bonds

• Straight fixed-rate bonds

• Floating rate notes

• Convertible bonds

• Bonds with equity warrants

(cont.

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Types of international bonds (cont.)

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Choice of currency of denomination

• Choose foreign bonds if:

i S

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International equity financing

• Primary market functions: underwriting of new equity issues

• Secondary market functions: trading of equities

abroad

15-15

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Reasons for listing on foreign stock exchanges

• To improve the liquidity of existing shares

• To boost political and commercial visibility in foreign countries

• To support a new equity issue

• To broaden ownership

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Costs of foreign listing

• One cost of foreign listing is greater disclosure

requirements

15-17

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Selling shares in international

markets

• Private placements underwritten by institutions from the host country

• Selling Euro-equity issues

• Selling a subsidiary’s shares to foreign investors

• Selling shares to a foreign firm to form an alliance

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Other sources of financing

• Parallel loans: a parallel loan involves an initial

exchange of funds between firms in different

countries, such that the transaction is reversed some time in the future

15-19

(cont )

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Australia (AUD funds)

Japan (JPY funds)

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Other sources of financing (cont.)

• Credit swaps: a credit swap makes it possible to

acquire a loan for a foreign subsidiary without having

to send funds abroad

• It involves the exchange of currencies between a

bank and a firm, not between two firms

15-21

(cont )

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Loan + interest

Australia (AUD funds)

Japan (JPY funds)

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• Government lending: governments of countries

acting as hosts to foreign direct investment may

provide financing when they believe that the

underlying projects will generate jobs, facilitate the

transfer of technology and/or provide training for

local workers

15-23

(cont )

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• Lending by international organisations: a number of development institutions grant developing countries loans to finance infrastructure projects

• While these loans are granted to the host

governments, the companies operating there are

financed indirectly

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Bond investment

• Foreign bonds are preferred if:

r r

S

15-25

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The effect of taxes

)

( τ

1

τ

1

r r

S

k y



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The effect of taxes (different rates)

r r

S  ( 1 τ y ) ( 1 τ y )

15-27

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P

P P

D R

0

1 0

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Foreign versus domestic

investments

• A foreign equity investment is preferred if:

) (

) ( d d a a S

15-29

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The effect of taxes

• A foreign investment is preferred if:

) (

)

( τ

1

τ

1

a a

d d

S

k y



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The effect of taxes (different rates)

• A foreign investment is preferred if:

a a

d d

S

k k

y y

) τ 1

( )

τ 1

(

) τ 1

( )

τ 1

(



15-31

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Share prices (Australia)

15-33

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Share prices (U.S.)

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Share prices (Japan)

15-35

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Share prices (U.K.)

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The rate of return

) , ( 2

) ( )

( )

2

S A

R

a d

A S

A R



15-37

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Combining domestic and foreign

securities

) ,

( ρ ) (

σ ) ( σ 2

) (

σ )

( σ )

( σ

)

(

2 2 2

2 2

R R R

R ww

R w

R

R w wR

R

E

p p

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The effect of correlation

= 1 No reduction in risk

< 1 Diversification reduces risk

= -1 Maximum risk reduction

15-39

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The efficient frontier

• The locus of points representing the combinations of risk and return of various portfolios for a constant

correlation coefficient

(cont.

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The efficient frontier (cont.)

A

(domestic)

) ( R ρ

σ R ρ

(foreign)

15-41

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The effect of international

diversification

• International diversification causes a shift in the

efficient frontier At the same level of risk, a higher

return can be obtained

(cont.

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The effect of international

diversification (cont.)

A

(domestic)

) ( R ρ

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Capital asset pricing model (CAPM)

• The expected return is positively related to its

systematic risk:

) (

σ

) ,

(

σ β

) (

β

2

m

m j

R

R R

i R

(cont.

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Capital asset pricing model (cont.)

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The value of

< 1 Lower than market portfolio

= 1 Equal to market portfolio

> 1 Higher than market portfolio

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ICAPM

• The model describes the relation between the

expected return and systematic risk when assets are priced in internationally integrated financial markets

15-47

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Implications of ICAPM

• Investors cannot obtain abnormal returns by

investing in foreign securities unless the markets are segmented

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Reasons for market segmentation

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Reasons for market segmentation (cont.)

• Political and country risk

• Transaction costs

• Taxation

• Domestic regulation

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