Chapter 17 Multinational Financial Management 551has occurred include Mexico and all the South American nations. On the other
hand, the currencies of Switzerland and Japan, which have had less in" ation than
the United States, have appreciated against the dollar. In fact, a foreign currency will,
on average, depreciate or appreciate at a percentage rate approximately equal to the amount
by which its in" ation rate is over or under the U.S. in" ation rate.
Relative in" ation also affects interest rates. Indeed, the interest rate in any
country is largely determined by its in" ation rate. So countries with higher in" a-
tion rates than the U.S. in" ation rate also have higher interest rates, and the reverse
is true for countries with lower in" ation rates.
It is tempting for a multinational corporation to borrow in countries with the
lowest interest rates. However, this is not always a good strategy. Suppose, for ex-
ample, that interest rates in Switzerland are lower than those in the United States be-
cause of Switzerland’s lower in" ation rate. A U.S. multinational! rm could therefore
reduce its interest expense by borrowing in Switzerland. However, because of rela-
tive in" ation rates, the Swiss franc will probably appreciate in the future, causing the
dollar cost of annual interest and principal payments on Swiss debt to rise over time.
Thus, the lower interest rate could be more than offset by losses from currency appreciation.
Similarly, multinational corporations should not necessarily avoid borrowing in a
country such as Brazil, where interest rates have been very high, because future de-
preciation of the Brazilian real could make such borrowing relatively inexpensive.
SELF^ TEST What e# ects do relative in! ation rates have on relative interest rates?
What happens over time to the currencies of countries with higher in! ation
rates than U.S. in! ation rates? To countries with lower in! ation rates?
Why might a multinational corporation decide to borrow in a country such
as Brazil, where interest rates are high, rather than in a country such as
Switzerland, where interest rates are low?17-9 INTERNATIONAL MONEY AND CAPITAL MARKETS
One way for U.S. citizens to invest in world markets is to buy the stocks of U.S. mul-
tinational corporations that invest directly in foreign countries. Another way is to
purchase foreign securities—stocks, bonds, or money market instruments issued by
foreign companies. Security investments are known as portfolio investments, and they
are distinguished from direct investments in physical assets by U.S. corporations.
For a time after World War II, the U.S. capital markets dominated world mar-
kets. Today, however, the value of U.S. securities represents less than one-fourth of
the value of all securities. Given this situation, it is important for both corporate
managers and investors to understand international markets. Moreover, these
markets often offer better opportunities for raising or investing capital than are
available domestically.
17-9a International Credit Markets
There are three major types of international credit markets. The! rst type is the
market for " oating-rate bank loans, called Eurocredits, whose rates are tied to
LIBOR, which stands for London Interbank Offer Rate. LIBOR is the interest rate
offered by the largest and strongest banks on large deposits. On May 26, 2008, the
3-month LIBOR rate was 2.65%. Eurocredits tend to be issued for a! xed term with
no early repayment. The oldest example of a Eurocredit is a Eurodollar deposit,
Eurocredits
Floating-rate bank loans
that are available in most
major trading currencies
and that are tied to LIBOR.Eurocredits
Floating-rate bank loans
that are available in most
major trading currencies
and that are tied to LIBOR.Eurodollar
A U.S. dollar deposited in a
bank outside the United
States.Eurodollar
A U.S. dollar deposited in a
bank outside the United
States.