Borrowing Koruna (The Czech Currency). It Would Also Need to Consider the Potential

FINANCING DECISION. Cuanto Corp (C) is a U.S. drug company that has attempted to capitalize on new opportunities to expand in Eastern Europe. The production costs in most Eastern European countries are very low, often less than one-fourth of the cost in Germany or Switzerland. Further there more, there is a strong demand for drugs in Eastern Europe. C penetrated Eastern Euroe by purchasing 60% stake in Galena AS a Czech firm that produces drugs.

a. Should C finance its investment in the Czech firm by borrowing dollars from a U.S. BANK that would then be converted into koruna from a local Czech bank? What information do you need to know to answer this question?

Cuanto would need to consider the interest rate in the U.S. versus the interest rate when

borrowing koruna (the Czech currency). It would also need to consider the potential

change in the koruna currency against the dollar. If it finances the project in dollars, it is

more exposed to exchange rate risk, because the funds would be remitted to the U.S. before

paying the interest expenses on the loan. Conversely, if it finances the project in koruna, it

could use some of its local funds to pay off its interest expenses before remitting any funds

to the U.S. parent. Another reason for borrowing from a local Czech bank is that the bank

may help Cuanto avoid any excessive regulatory restrictions that could be imposed on

foreign firms in the drug industry. These potential advantages of borrowing locally must be

weighed against the potentially higher interest rate when borrowing locally.

b. How can borrowing koruna locally from a Czech bank reduce the exposure of C to exchange rate risk?

By borrowing koruna, the Czech subsidiary of Cuanto should make its interest payments before remitting any funds to the parent. Therefore, there are less funds that have to be remitted (less exposure) than if the funds are remitted to the U.S. before interest payments are paid to a U.S. bank.

c. How can borrowing koruna from a Czech bank reduce the exposure of C to political risk caused by government regulations?

By borrowing from a local Czech bank, Cuanto may be able to avoid excessive regulations that could be imposed on foreign firms by the local government. Also, there is less chance of any extreme action to be taken on a foreign firm when that firm’s failure would cause defaults on loans provided by local lenders.