Abstract

Multinationals, Hedging, and Capital Structure under Exchange Rate Uncertainty

Kit Pong WONG
Udo BROLL

University of Hong Kong
University of Saarland

This paper examines the interplay of the financing and hedging decisions of a risk-averse multinational firm having a wholly-owned foreign subsidiary. Exchange rate risk management of the multinational firm is shown to have direct impacts on its international capital structure decision and on its currency of denomination decision. If a currency forward market exists, the multinational firm will devise its international capital structure so as to minimize the global weighted average cost of capital. Or else the multinational firm has to rely on a money market hedge through issuing more foreign currency denominated debt and less domestic currency denominated debt, thereby resulting in a higher global weighted average cost of capital. Such a distortion would be alleviated should the parent be more profitable. In contrast, if the foreign subsidiary is more profitable, it is likely that the global weighted average cost of capital is further pushed up.