Question

                                                                                                               Analytical Application

                                                                                                    Using International Financial Markets

Worcester Tool Company is a large, U.S.-based, multinational corporation with subsidiaries in eight different countries. The parent of Worcester provided an initial cash infusion to establish each subsidiary. Each subsidiary, however, has had to finance its own growth since then. The parent and subsidiaries of the firm typically use Citigroup (with branches in numerous countries) when possible to facilitate any flow of funds necessary.

a. Explain the various ways in which Citigroup could facilitate Worcester’s flow of funds, and identify the type of financial market where that flow of funds occurs. For each type of financing transaction, specify whether Citigroup would serve as the creditor or would simply facilitate the flow of funds to the firm.

b. Recently, the British subsidiary called on Citigroup for a medium-term loan and was offered the following alternatives.

LOAN DENOMINATED IN                                       ANNUALIZED RATE

British pounds    13%

U.S. dollars                                                                    11%

Canadian dollars                                                          10%

Japanese yen                                                                  8%

Answer 1

a. Citigroup can facilitate Worcester’s flow of funds by providing the entity and its subsidiaries short term loans. Short term loans can be provided to Worcester and its subsidiaries to finance its short term assets like inventories. Secondly Citigroup can facilitate Worcester’s flow of funds by providing the entity and its subsidiaries long term loans. Long term loans can be provided to Worcester and its subsidiaries to finance its long term assets like property, plant and equipment. In both these cases (short term loans and long term loans) Citigroup will serve as the creditor.

Thirdly Citigroup can facilitate Worcester’s flow of funds by acting as a custodian in case the entity wants to float ADR (American Depository Receipt) or GDR (Global Depositary Receipt). Citigroup can help Worcester to issue ADR/GDR in foreign currency. Lastly Citigroup can act as a facilitator if Worcester wants to issue bonds for the purpose of raising capital. In both these cases (ADR/GDR, bonds) Citigroup will serve as a facilitator.

b. Worcetser, in an ideal situation, would like to borrow money at the minimum annualized rate. Given the provided rates we can see that the rate for loan that is denominated in Japanese Yen (JPY) is the least at 8%. But still, an analysis will have to be done, so as to determine the best financing option.

Japanese Yen (JPY) : Over the last three years JPY has depreciated against the British Pound (GBP). This situation augurs well for the company if it continues in the future as well. If the value of Japanese Yen in the future still keep decreasing in value when there is a due date for the British Subsidiary to repay the loan because they can benefit from the appreciation of the British Pound.

US Dollar (USD): There is a high volatility that has been exhibited by the exchange rate between USD and GBP. Thus taking a loan in USD will be risky for the company. As such Worcester should avoid taking loan in USD. Besides volatility the rate is 11%, much higher than rates of JPY of 8% and Canadian dollars of 10%.

Canadian dollar: This currency has largely appreciated against GBP and has exhibited a sense of stability. If the British Pound deprecates against the Canadian dollar as it generally is at the end of the loan, then the company will lose benefit from the exchange rate.

Thus, on analysis of the above scenarios, we can conclude that taking a loan in JPY is optimal for the company. The British subsidiary will, in future, have to consider exchange rate risk. They will also have to consider political and the economic condition in Japan that will add to the risk for the company.