Parallel loan
 | This article, Parallel loan, has recently been created via the Articles for creation process. Please check to see if the reviewer has accidentally left this template after accepting the draft and take appropriate action as necessary.
Reviewer tools: Inform author |
Definition
“Parallel loan refers to a loan that exchange of currencies between four parties which promises that the loan will be repaid at a specified future date and predetermined exchange rate”.[1]It consists of two pairs of the affiliated companies and two pairs parents companies in two different countries.[1] It occurs between two companies simultaneously when a company has a relative advantage in the cost of funds and then borrows those funds to a foreign affiliate in its own country at a rate lower than the foreign affiliate would have to pay at its parent company’s country.[2] Besides that, the parallel loan is “similar to cross-border loan, but there are no currencies in the foreign exchange markets”.[3]
The parallel loan is also known as the back-to-back loan. The parallel loan was one of the proactive management of operating exposure that offsetting expected foreign exchange exposure. Two business companies in different countries will borrow currency to each other for a particular period of time and they will return the borrowed currencies on the date they agreed to with the same loaned amount. The two loans will be valued at the prevailing spot rate and the prescribed period. The currencies borrowing activities conducted outside the foreign exchange market to avoid foreign exchange risk and legal limitations.
Example
“Parallel loan happens in a situation where two companies in two different countries that provide loans to the opposite subsidiaries simultaneously. For instance, both of the Japan and U.S. companies have its subsidiary at its respectively country. Both Japan and U.S. companies want to raise funds to its own subsidiary company. The U.S. based company and Japanese based company can utilize the concept of the parallel loan by borrowing from respective banks to provide loans to opposite subsidiaries to avoid the currency risks and increases in the cost of funds. Assume that the interest rate in the U.S. are 5 percent for domestic companies and 7 percent for foreign companies while interest rate in Japan is 4 percent for local companies and 6 percent for foreign companies. In parallel loan, the U.S. based companies borrow a certain amount at 5 percent interest rate and lend the funds to the Japanese subsidiary in the United States at 5 percent saving the Japanese subsidiary 2 percent. Similarly, the parent companies in the Japan borrows a loan at 4 percent and lends the amount to the U.S. subsidiary at 4 percent interest rate. Both of the subsidiaries can use the revenues that earned in the country to repay back to the lending parent companies”.[2]
History
“Parallel loan was established in the early 1970s in effect of the exchange controls in the United Kingdom on British companies”.[4]The implementation of exchange control has caused many British firms withdrawn their decision to extend their business because investing in foreign market is not attractive. After the abolition of foreign exchange control in 1979, parallel loan kept on being utilized with the goal of hedging long-term foreign currency exposure at a lower cost than what will be imposed in the foreign exchange market.[4] At that time, UK organizations needed to pay a premium to get a loan in US dollars. In order to prevent this situation, UK organizations set up parallel or back-to-back loan agreement with US organizations that wish to acquire sterling.[5] The parallel loan market was created to avoid confinements imposed by the Bank of England on the free stream of British pounds. Most of the British companies who are desire to invest abroad need to change pounds into US dollars at an exchange rate over the market exchange rate. The motivation behind this strategy was to safeguard the value of the pound among other currencies. However, companies actually were not keen on providing financial aid to the Bank of England by committing the above-market rate for every dollar obtained from the exchange rate implemented in the policy. Prevention for these currency control leads straightforwardly to the improvement of the market for the currency swaps.[6]
Advantages & Disadvantages
Parallel loan not only evolved to circumvent exchange control regulations, but it also permits companies to borrow funds in foreign currencies at rates lower than they might get in foreign exchange market, as overseas companies. In this situation, the parallel loan brings a few advantages and disadvantages to the companies.
Advantages
- Cost of the fund is fixed: The transfer of funds is less costly for both companies compared to the cost of financing from its parent company and loans from banks. In addition, the subsidiary in the country may face the problem of higher lending cost from banks if the subsidiary is not well known and its credit rating may not as high as its parent company.[7]
- Protect against exchange rate risk: There is no foreign exchange exposure since it uses local currency where the subsidiaries are located and there is no need to enter the foreign exchange market to repay back the loans.
Disadvantages
- Hard to find counterparties with the matching needs: Company may face the problem of finding its counterparty with the mirror image financing needs with another company such as the currencies, principals, type of interest payments, frequency of the interest payments and length of the loan period.
- Obligated to comply with an agreement even opposite party fails to fulfill the obligation: In order to prevent this situation happen, a separate agreement is registered to offset the party who being defaulted by another party.[1]
- Large fees imposed on matching two companies: There is a need to hire a brokerage or investment banker to arrange this type of transactions and the companies who hire need to paid an amount of fees to the brokerage houses.[8]
References
- ^ a b c Kim, Kenneth A.; Kim, Suk H. (2015). Global Corporate Finance: A Focused Approach. World Scientific Publishing Co Inc. ISBN 9789814618021.
- ^ a b Siddaiah, Thummuluri (2010). International Financial Management. Pearson Education India. ISBN 9788131717202.
- ^ SHARAN, VYUPTAKESH (2012). INTERNATIONAL FINANCIAL MANAGEMENT. PHI Learning Pvt. Ltd.
- ^ a b Moosa, Imad A. (2009). International finance : an analytical approach (3rd ed. ed.). North Ryde, N.S.W.: McGraw-Hill Australia. ISBN 9780070278516.
{{cite book}}:|edition=has extra text (help) - ^ O'Malley, Chris (2015). Bonds without Borders: A History of the Eurobond Market. John Wiley & Sons. ISBN 9781118843888.
- ^ W. Kolb, Robert (2010). Financial derivatives : pricing and risk management (New ed. ed.). Hoboken, N.J.: John Wiley & Sons. ISBN 9780470499108.
{{cite book}}:|edition=has extra text (help) - ^ Homaifar, Ghassem A. (2004). Managing global financial and foreign exchange rate risk. Hoboken, N.J.: J. Wiley. ISBN 9780471281153.
- ^ Murray, Tracy (1988). Handbook of international management. New York: Wiley. ISBN 9780471606741.
| This article, Parallel loan, has recently been created via the Articles for creation process. Please check to see if the reviewer has accidentally left this template after accepting the draft and take appropriate action as necessary.
Reviewer tools: Inform author |