## **Learning Outcomes**

After reading this article, you will be able to identify and compare major sources of international finance, critically assess the implications of funding in various currencies, explain how currency choices influence exposure to exchange risk, and advise on structuring global finance for multinational companies. You will understand the exam-relevant features, risks, and strategies required for optimal cross-border financial decision-making.

## **ACCA Advanced Financial Management (AFM) Syllabus**

For ACCA Advanced Financial Management (AFM), you are required to understand the international financing environment, sources of global funds, and the impact of currency choice on financial structure. In particular, focus your revision on:

- The characteristics and suitability of key international sources of finance for multinational companies
- Factors affecting the choice between financing in local or foreign currency
- Risks arising from currency mismatches in funding and project flows
- The rationale and structure of currency hedging strategies within financing arrangements
- Foreign exchange exposure arising from funding decisions
- Treasury management practices in sourcing and managing global funds

## **Test Your Knowledge**

_Attempt these questions before reading this article. If you find some difficult or cannot remember the answers, remember to look more closely at that area during your revision._

1. Which of the following is a principal reason for a multinational to raise finance in a foreign currency?
   a) Improve domestic interest coverage ratios  
   b) Reduce translation risk on local assets  
   c) Achieve a natural hedge against project cash flows  
   d) Eliminate all political risk

2. True or false? Eurobonds are subject to the regulations of the country where the borrowing company is headquartered.

3. A UK company invests in a Malaysian manufacturing project and considers borrowing in US dollars or Malaysian ringgit. What are two risks in choosing US dollar funding if project cash flows are in ringgit?

4. List three main sources of long-term finance available to a multinational company planning a major overseas investment.

## **Introduction**

International financing is a central concern for multinationals operating across borders. Choosing appropriate sources of funds and deciding which currency to finance in can significantly affect project viability, risk exposure, and shareholder value. Financial managers must evaluate available instruments, market conditions, regulatory constraints, and the interaction with currency risk to optimise global financing structures.

This article provides a practical and exam-focused overview of the main international finance options, the implications of currency choice, and the factors influencing optimal funding decisions for multinational enterprises.

## SOURCES OF INTERNATIONAL FINANCE

Multinational companies require substantial capital for foreign projects, investments, or acquisitions. Access to diverse financial markets provides numerous funding options—each with benefits, limitations, and risk profiles.

### Major Types of International Funding

- **Parent Company Finance**: The parent raises funds in its home market and injects them into the subsidiary as equity or loans.
- **Local Subsidiary Finance**: The subsidiary raises funds directly in the host country, usually in the local currency.
- **International Markets**: The company issues equity or debt in overseas stock markets or borrows through syndicates, Eurobonds, or commercial banks.
- **Third-Currency Finance**: Funds are raised in a currency different from both the parent and the host (e.g., US dollars for a project in Brazil by a UK firm).

> **Key Term: Eurobond**
> A long-term debt instrument issued in a currency different from the country where it is offered, typically under less stringent regulation and outside domestic boundaries.

- **Project Finance**: Large standalone projects may be financed through special purpose vehicles, with recourse only to project cash flows.

### Factors Determining Funding Source

- Cost and availability of funds
- Taxation and regulatory restrictions (e.g., capital controls)
- Political and economic stability in host and parent countries
- Flexibility and covenants in financing arrangements
- Acceptability to local stakeholders and authorities

## CHOOSING FUNDING CURRENCY

Selecting the currency in which to borrow is a critical decision. Currency mismatches between debt service and project income create potential exchange risks.

> **Key Term: natural hedge**
> Aligning the currency of cash inflows and outflows to reduce net exposure to exchange rate fluctuations.

### Practical Considerations

- Borrowing in the same currency as project revenues is generally preferred to reduce transaction risk.
- Parental guarantees may be needed if local borrowing is restricted or expensive.
- Financial market depth and cost of capital differ between currencies and locations.
- Currency choice must also account for potential depreciation of the funding currency versus the operational currency.

### **Worked Example 1.1**

**Scenario:**  
A German multinational invests in a South African subsidiary, expecting all project revenues in South African rand. It considers raising debt in euros or rand.

**Question:**  
What are the possible implications of choosing euro- instead of rand-denominated debt?

> **Answer:**
>
> If the firm borrows in euros but earns in rand, a depreciation of the rand versus the euro will increase the local-currency cost of debt service, eroding profits or causing cash flow shortfalls. Borrowing in rand would reduce this transaction risk, matching funding and operational currencies and creating a natural hedge.

## FOREIGN EXCHANGE RISKS IN FUNDING

Funding decisions can result in various foreign exchange exposures:

> **Key Term: transaction risk**
> The risk that currency movements will change the value of settled cash flows between different currencies.
>
> **Key Term: economic risk**
> The risk that currency fluctuations will impact the present value of future cash flows and long-term competitiveness.
>
> **Key Term: translation risk**
> The impact of currency changes on the reporting of foreign assets, liabilities, and profits when consolidating financial statements.

## STRUCTURING FINANCING TO MANAGE RISK

To manage foreign currency exposures, companies employ various structuring strategies:

- **Matching:** Aligning borrowings and revenue streams in the same currency.
- **Currency Swaps:** Exchanging principal and interest payments in different currencies with a counterparty.
- **Diversified Currency Borrowings:** Using a portfolio of funding currencies to spread risk.
- **Hedging:** Using financial instruments such as forwards or options to lock in exchange rates or limit losses.

### **Worked Example 1.2**

**Scenario:**  
An Australian mining group expects half its revenues in US dollars and half in euros. Describe a funding approach to minimise exchange risk.

> **Answer:**
>
> The company should structure borrowings so that debt service obligations roughly mirror the split of anticipated revenues (e.g., half in dollar debt, half in euro debt). This provides a natural hedge—gains in one currency offset losses in the other if rates fluctuate.

### **Exam Warning**

> Exchange rates can move significantly during a project's life. Exam answers should always discuss potential adverse movements, even if the proposed structure looks balanced initially.

## COMPARISON OF FUNDING OPTIONS

| Option                 | Key Features                                      | Main Advantages              | Main Risks                        |
| ---------------------- | ------------------------------------------------- | ---------------------------- | --------------------------------- |
| Parent company finance | Raised and controlled centrally                   | Easier access, control       | Exposed to currency mismatch risk |
| Local subsidiary loan  | Raised in project country/currency                | Natural hedge, local support | May be restricted, higher costs   |
| International funding  | Via global markets, in various currencies         | Large amounts possible       | Transaction & economic risk       |
| Third-currency funding | Borrowing in a currency other than parent or host | Sometimes lowest rates       | Highest currency mismatch risk    |

### **Worked Example 1.3**

**Scenario:**  
A UK group considers borrowing Japanese yen for a Mexican project, as the interest rate is lowest.

**Question:**  
Why might this approach be risky?

> **Answer:**
>
> Any adverse movement between the yen and the Mexican peso (or the UK pound, depending on the ultimate reporting currency) can rapidly increase the sterling cost of debt. Low interest costs may be offset by exchange losses, especially if the project's revenues are not in yen. This strategy is speculation on currency movements, not a reliable cost-saving measure.

## FINANCIAL STRUCTURING IN MULTINATIONALS

Large groups typically centralise key treasury functions to benefit from:

- Economies of scale in borrowing and investing
- Consistent risk management policies
- Enhanced bargaining power with lenders
- Centralised liquidity, reducing idle cash balances

> **Key Term: centralised treasury**
> A group-wide department responsible for pooling cash, managing funding, and controlling financial risk across all subsidiaries.

### Local versus Centralised Structure

- Centralisation offers efficiency and stronger risk control.
- Decentralisation gives subsidiaries more autonomy and may be advantageous where local conditions vary widely.

## SUMMARY

Effective international financing and structuring require careful selection of both funding source and currency, with decisions shaped by risk, cost, regulatory, and operational factors. Funding in project-matching currency generally reduces risk, while mismatches need to be managed with appropriate hedging. The structuring of global finance draws on both local and international markets and is coordinated by treasury functions to maintain flexibility and control exposures.

## **Key Point Checklist**

_This article has covered the following key knowledge points:_

- International sources of finance: parent, host, international, and third-country
- Importance of aligning borrowing currency with project cash flows (natural hedge)
- Main types of foreign exchange exposure from funding decisions
- Risk management through matching, swaps, and diversified currency borrowings
- Advantages and disadvantages of centralised treasury structures in global finance

## **Key Terms and Concepts**

- Eurobond
- natural hedge
- transaction risk
- economic risk
- translation risk
- centralised treasury


International financing and structuring - Sourcing funds and currency choice