Multinational firms may lower borrowing costs by taking out loans in Eurodollars or through foreign subsidiaries in local currencies with lower interest rates than the U.S. prime rate. They convert these into dollars, but this strategy is risky due to potential exchange rate fluctuations, which can lead to financial losses if the local currency depreciates.
Multinational firms have found ways to lower borrowing costs by taking advantage of the difference in interest rates between countries. They can do this by borrowing Eurodollars at a rate lower than the U.S. prime rate, or by borrowing foreign currencies through foreign subsidiaries at rates lower than the U.S. prime rate. Then, they convert these foreign loans into dollars. This process, while effective in managing costs, carries risks due to potential exchange rate fluctuations. If the domestic currency depreciates against the borrowed foreign currency, the cost of repaying the loan can increase significantly, potentially leading to financial strain.
For instance, if a bank in Thailand borrows U.S. dollars and then lends out the baht after conversion, it expects to get repaid in baht. If the baht depreciates against the U.S. dollar, when the bank converts the repaid baht to dollars, it will receive fewer dollars than it borrowed, causing a shortfall.
In a scenario where the exchange rate shifts from 40 baht/dollar to 50 baht/dollar, the Thai bank would be unable to repay the original U.S. dollar loan without incurring losses. Conversely, if the baht strengthens, the bank could stand to gain.