Question

Ventura Corp., a U.S. based MNC, plans to estab¬lish a subsidiary in Japan. It is confident that the Japanese yen will appreciate against the dollar over time. The subsidiary will retain only enough revenue to cover expenses and will remit the rest to the parent each year. Will Ventura benefit more from exchange rate effects if its parent provides equity financing for the subsidiary or if the subsidiary is financed by local banks in Japan? Explain.

Answer 1

The finance should be done by equity financing.

Country's currency will appreciate when the country starts to offer higher interest rate, so that every other country starts to invest in that country. So if the borrowing rate is high, then the lending rate will also be high. As it is expected that Japan's currency will appreciate, so borrowing from japan will be costly and it will eat up the translation gain due to currency appreciation.

So the US company in order to enjoy the currency appreciation of subsidy in Japan should do Equity Financing and then enjoy translation gain when converting Japanese Yen to USD.