Short term loan
Management of short-term assets and liabilities ; cash, investments, inventories, receivable, payables , is an important part of the finance manager's job.
The essence of short-term financial management can be stated as:.
Minimize the working capital needs consistent with other policies.
Raise short term funds at the minimum possible cost and deploy short term cash surpluses at the maximum possible rate of return consistent with the firm's risk preferences and liquidity needs. In a multinational context, the added dimensions are the multiplicities of currencies and a much wider array of markets and instruments for raising and deploying funds.
SHORT-TERM BORROWING AND INVESTMENT .
International money markets particularly in well-developed financial centres like London, New York, and Tokyo offer a variety of instruments to raise short-term financing as well as place short-term funds. The principal dimensions of the borrowing-investment decisions are the instrument, currency, location of the financial center, and any tax related issues. Between them, they decide the cost of or return on funds, extent of currency exposure, the ease with which funds can be moved from one location and currency to another, and thus the overall efficiency of the cash management function. Apart from bank loans, the other major instruments for short-term funding are commercial paper and in the US domestic money market, bankers, acceptances. Commercial paper as a funding device is accessible only to corporations with high creditworthiness. For such entities, it is a cheaper form of funding than a bank loan.
On a covered basis, yields are equal across Eurocurrencies. Hence, on a covered basis, the choice of currency of borrowing does not matter. Only when the borrower firm holds views regarding currency movements which are different from market expectations as embodied in the forward rate, does the currency of borrowing become an important choice variable. The risk premium can be negative or positive depending upon whether speculators as a group are required to be net short or long in the forward market. Thus, the forward rate can on average equal the future spot rate even in the presence of a constant risk premium. However, in a particular instance, a firm may have reasons to believe that the forward rate is an underestimate or overestimate of the future spot rate. In such cases, the firm should compare the effective expected cost of borrowing across different currencies and choose the least cost alternative. Note that this involves risk, and any saving on borrowing cost reflects compensation for the added risk.
Following the same reason, on a covered basis the firm should be indifferent between various currencies when it comes to placing temporary excess funds since the covered yields are identical. Considerations such as availability of various investment vehicles , deposits, CDs, CP, treasury bills and so on and their liquidity may lead to one currency being favored over another. A firm willing to take on added risk can make uncovered investments hoping to profit from its superior forecasting ability.
WHERE SHOULD SURPLUS BE HELD .
In a multinational corporation with production and selling subsidiaries spread around the world, cash inflows and outflows occur in diverse currencies. Apart from cost and return considerations, several other factors influence the choice of currencies and locations for holding cash balances. The bid-ask spreads in exchange rate quotations represent transaction costs of converting currencies into one another. There may of course be other costs such as telephone calls, telexes, other paperwork and so on. Minimizing transaction costs would require that funds be kept in the currency in which they are received if there is possibility that they might be needed later in the same currency. A related but distinct consideration is that of liquidity, viz. funds should be held in a currency in which they are most likely to be needed. However, this consideration would influence the location of the financial center where the funds are held, rather than the currency and is likely to be of some importance only in case of politically highly unstable countries.
Availability of investment vehicles and their liquidity is another important factor. Major money market centres such as London, New York, Zurich and so forth offer a wide variety of highly liquid money market instruments so that the firm does not need to hold practically any idle cash balances. Finally, withholding taxes may influence the choice. If balances are held in interest bearing assets in a country which has a withholding tax on non-resident interest income, and the tax rate exceeds the parent ?s home country tax rate, the parent may not be able to get full credit for the foreign tax paid and such a location may therefore become unattractive for holding funds.
INVESTING SURPLUS FUNDS .
Once the treasurer has identified the cash flows and determined how much surplus funds are available in which currencies and for what durations, he or she must choose appropriate investment vehicles to maximize the interest income, while at the same time minimizing currency and credit risks and ensuring sufficient liquidity to meet any unforeseen cash requirements.
The major investment vehicles available for short-term placement of funds are :.
Short-term bank deposits.
Fixed-term money market deposits such as CDs.
Financial and commercial paper.
The main considerations in choosing an investment vehicle can be summarized as follows:
Yield .
Total return on the investment including interest income and any capital gain or loss is termed as "Yield". Very often, security and liquidity considerations may take precedence over yield.
Marketability .
Since liquidity is an important consideration, the ease with which the investment can be unwound is important. Instruments like CDs have well developed secondary markets while CPs and trade related paper have limited liquidity.
Exchange Rate Risk .
If funds eventually required in currency "A" are invested in currency "B", there is exchange rate risk. If covered, there is no advantage to switching currencies.
Price Risk .
If a fixed-term investment such as a CD or a T-bill has to be liquidated before maturity, there is the risk of capital loss if interest rates have moved up in the meanwhile.
Transaction Costs .
Brokerage commissions and other transaction costs can significantly lower the released yield particularly on short-term investments. Money-market investments are often available in fixed minimum sizes and maturities, which may not match the size of the available surplus and the duration for which it is available.
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