SMALL BUSINESS DILEMMA
Short-Term Financing by the Sports Exports Company
At the current time, the Sports Exports Company focuses on producing footballs and exporting them to a distributor in the United Kingdom. The exports are denominated in British pounds. Jim Logan, the owner, plans to develop other sporting goods products besides the footballs that he produces. His entire expansion will be focused on the United Kingdom, where he is trying to make a name for his firm. He remains concerned about his firm's exposure to exchange rate risk but does not plan to let that get in the way of his expansion plans because he believes that his firm can continue to penetrate the British sporting goods market.
He has just negotiated a joint venture with a British firm that will produce other sporting goods products that are more popular in the United States (such as basketballs) but will be sold in the United Kingdom. Logan will pay the British manufacturer in British pounds. These products will be delivered directly to the British distributor rather than to Jim, and the distributor will pay Logan with British pounds. Logan's expansion plans will result in the need for additional funding. Logan would prefer to borrow on a short-term basis now. He has an excellent credit rating and collateral and therefore should be able to obtain short-term financing. The British interest rate is onefourth of a percentage point above the U.S. interest rate.
1. Should Logan borrow dollars or pounds to finance his joint venture business? Why?
2. Logan could also borrow euros at an interest rate that is lower than the U.S. or British rate. The values of the euro and pound tend to move in the same direction against the dollar but not always by the same degree. Would borrowing euros to support the British joint venture result in more exposure to exchange rate risk than borrowing pounds? Would it result in more exposure to exchange rate risk than borrowing dollars?