Question

In recent years, some Asian-based MNCs have taken advantage of the very low interest rates in Europe by borrowing large amount of euro to finance their operations. Write a short essay that explains the advantages and possible disadvantages (if any) due to this type of financing. Show how you do you estimate these borrowings in the short term and long term. How does euro appreciation and depreciation affect the cost of capital of Asian-based MNCs.

Answer 1

Loan financing refers to raising funds for banks and lending agencies. Cross-border financial transactions involve international borrowing and lending from international banks and other lenders. The difference between interest rate, currency value, exchange rate, and inflation rate provides profit to the borrowers.

 

As per the given information, Asian MNCs take loans from European banks and lenders at low-interest rates. These low-cost loans provide benefits to the borrowing companies. The major reason for the low interest is the inflation rate and exchange rate. 

 

Advantage of international lending system with low-interest rate:

• These types of loans create less burden for the repayment of principal loan amount and periodic interest.
• The fluctuations in the exchange rates in the favorable direction provide more value of loans and create less value of the liability.
• If the loan is taken from a country having a low inflation rate, the interest rate becomes low.

 

The disadvantage of international lending system with low-interest rates:

• These loans can also create a burden if the interest rate is high. The high interest negatively affects the cash flows of the borrowers.
• International borrowing requires various host countries and home country's rules, which create hurdles for the borrowers.

 

The value of borrowing can be estimated with the requirements of the company. The level of borrowings is depended upon the long-term and short-term requirements. These loans can be arranged from any type of organization.

 

Effect of appreciation and depreciation of Euro currency on loans taken by Asian countries' MNCs:

 

The appreciation in the value of the Euro is negatively affecting the borrowings by the Asian Countries' MNCs. If the value of 1 euro rises to 1.1 in the future, then the borrower needs to repay the loans at greater rate.