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ACCA Strategic Professional · Advanced Financial Management · International investment and financing decisions

A UK-based multinational wants to finance a new subsidiary in Brazil whose revenues are in Brazilian reais. Which financing choice would best reduce the subsidiary's transaction and economic exposure to currency movements?

Borrowing in reais from a local bank is best, because debt service is then in the same currency as the subsidiary's revenues. This creates a natural hedge, so currency falls reduce both inflows and repayments, while sterling or dollar debt would leave a currency mismatch.

  1. ABorrow in reais from a local bank so that debt service is matched to reais cash inflowsCorrect
  2. BBorrow in sterling because the parent reports in sterling
  3. CBorrow in US dollars because it is the most liquid currency
  4. DFund the subsidiary entirely with parent equity to avoid any currency link

Explanation

Matching the currency of borrowing to the currency of the project's cash inflows creates a natural hedge, since a fall in the real reduces both revenue and debt service in sterling terms. Sterling or dollar debt leaves a mismatch between inflows and outflows. Parent equity funding does not remove translation or economic exposure on the investment.

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