Question

How can home bias affect the cost of capital of domestic firms? Explain.

Answer 1

Domestic firms are affected by home buyers because they are always trying to take their financing within the domestic territory and they do not engage into taking international form of Finance because they are stuck with home bias as they are highly prejudiced with taking loans from the domestic institution but it is not a good strategy because it is lending to a higher cost of capital for these companies and lack of diversification for these companies as well.

When the companies are increasing into getting loans from outside the domestic territory, it will mean that they are not only just lowering their cost of capital but they are also making a significant presence in the international market and it will also mean that they are diversifying their exposure so it will offer them with optimum benefits once the firm get out of the home bias, so the firm should be trying to always expand itself and work upon the economies of scale and maximize its rate of return by getting exposed to the external markets.

Firm who are facing home bias are having a higher cost of capital and they are not completely diversified and they are also having a higher risk of insolvency because they are only concentrated into the domestic economy.

Answer 2

Home buyers is a biasness of domestic companies to to raise its capital in the domestic country itself and it does not look for raising capital outside the domestic territory so it will having a significant disadvantage when we will be looking it at perspective of lowering the cost of capital because all those companies who are operating through Global markets are trying to raise the Global financing in order to reduce their overall cost.

Home buyers is leading to increasing the cost of capital of various domestic company because the domestic company is not trying to look beyond the domestic market to to raise the cost of capital because there are various Global markets in which there will be various economic situations during various economic cycles which will offer these companies with lower cost of capital.

Hence, home biasness is leading to increase in the cost of capital of the domestic companies.