Question

a.  Explain the difference in the cost of financing with foreign currencies during a strong Australian dollar period versus a weak Australian dollar period for an Australian company.

b.  Explain how an Australian-based MNC issuing bonds denominated in Malaysian ringgit may be able to offset a portion of its exchange rate risk.

For part (b) assume the company is trying to raise capital and simultaneously reduce risk.

Answer 1

a.  Explain the difference in the cost of financing with foreign currencies during a strong Australian dollar period versus a weak Australian dollar period for an Australian company.

Answer:

First of all you need to understand what is cost of Financing ,

Cost of financing is the interest cost you have pay for the borrowed amount.

In this Example , Australian Company is borrowing in a Foreign Currency ,therefore interest also has to be paid in a Foreign Currency.

During a Strong Australian Dollar Interest cost in Australian Dollar terms will be lower as less Australian Dollars will be required to buy same amount of foreign currency ( In which interest has to be paid). Therefore, cost of financing will be lower.

However , during weak Australian Dollar Interest cost in Australian Dollar terms will be higher as more  Australian Dollars will be required to buy same amount of foreign currency ( In which interest has to be paid). Therefore ,Cost of financing will be higher.

b.  Explain how an Australian-based MNC issuing bonds denominated in Malaysian ringgit may be able to offset a portion of its exchange rate risk.

For part (b) assume the company is trying to raise capital and simultaneously reduce risk.

Answer:

Australian-based MNC issuing bonds denominated in Malaysian ringgit means it is borrowing in Malaysian ringgit ,therefore, it it is having exposure in Malaysian ringgit equivalent to issued bond value.Payment will have to be done in Malaysian ringgit.

With fluctuations in Australian dollar against Malaysian ringgit cost of repayment will also go up and down to cover this position Malaysian ringgit, Company can adopt various strategies to offset a portion of its exchange rate risk:

• Company can buy Malaysian ringgit in forward market to match it repayment requirement in Malaysian ringgit
• Company can take up offsetting position in Future Market or Option Market
• Company can denominate its Export receivables in Malaysian ringgit
• May go for a Swap.