Before we examine various funding avenues in the global market we must discuss the issues involved in choosing a particular mix of financing in terms of markets, currencies and instruments.
Before we
examine various funding avenues in the global market we must discuss the issues involved
in choosing a particular mix of financing in terms of markets, currencies and instruments.
The issue of the
optional capital structure and subsequently the optimal mix of funding instruments is one of the key
strategic decisions for a corporation. The actual implementation of the selected
funding programme involves several other considerations such as satisfying all the regulatory requirements, choosing the right timing
and pricing of the issue, effective marketing of the issue and so forth.
The optimal
capital structure for a firm or, in other words, corporate debt policy has been a subject of a long-running debate in finance literature since the
publication of the seminal paper by
Modigliani and Miller which argued that in the absence of taxes, capital structure does not matter.
The issue of the
optimal composition of a firm’s liability portfolio. The firm usually has a wide spectrum of funding avenues to
choose from. The critical dimensions of this
decision are discussed
below.
Interest rate basis: Mix of fixed rate and floating rate debt.
Maturity: The appropriate maturity
composition of debt.
Currency composition of debt.
Which market segments should
be tapped?
For instance,
long-term financing can be in the form of a fixed rate bond or an FRN or short-term debt like commercial paper repeatedly rolled
over. Each option
has different risk characteristics.
Individual financing
decisions should thus be guided by their impact on the characteristics-risk and cost-of the
overall debt portfolio as well as possible effects on future
funding opportunities.
In viewing the
risks associated with funding activity, a portfolio approach needs to be adopted. Diversification across
currencies and instruments enables the firm to reduce the overall
risk for a given funding
cost target. It also helps to increase
investors’ familiarity with the firm which makes future
approaches easier.
It should be
kept in mind that currency and interest rate exposures arising out of funding decisions should not be viewed in isolation. The firm should take a total view of all exposures, those arising out of its operating business and those on
account of financing decisions.