Question

Given the globalization of business, should firms look outside their own borders for short-term financing? What are the advantages and disadvantages of doing this?

Answer 1

Short term financing with a period of upto one year is utilized to enable companies to expand stock requests, payrolls, and day to day supplies. International short term financing include the impact of exchange rate fluctuations, potential exchange controls and multiple tax jurisdiction . It also involves a wider range of financing sources and investment outlets. Accessing offshore financial markets involves high fixed costs. Companies of uncertain quality are likely to be charged a higher risk premium since a lack of familiarity exacerbates the problems of informational asymmetries. Access to offshore bond markets might also be more costly for firms based in countries with poor legal sytems or weak institutions. Firm's demand for offshore bond financing depends on their ability to raise funds locally. If borrowing in domestic markets is relatively constrained, as is the case in less developed domestic financial markets, an easing of external financing conditions increases the incentive to issue debt offshore. Advantages include - maximum rate of return on short term investment , bettter risk-return trade off. A short term need is met through borrowing funds at a lower interest through trade credit, commercial paper, etc. Firms should look outside their own borders for short term finance. For Example, Avon used foreign financing during Asian crisis during 1997 and 1998 to offset foreign currency inflows. MNCs that conduct business in countries with high interest rates incur a high cost of short term financing if they finance in local currency. So they consider financing with another currency that has a low interest rate.