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Turn lends the money to a subsidiary in country B. These transactions are shown in Exhibit 14.5.

By
contrastions with a direct intercompany loan, the figure reveals that, in effect, a back-to-back loan is an
intercompany loan channelled through a bank. From the banks poin of view, the loan is risk free
because the parents deposit fully collateralizes it. The bank simply acts as an intermediary or a front;
compensation provided by the margin between the interest received from the borrowing unit and the
rate paid on the parents deposit.

A back-to-back loan may offer several potential advantages when compared with a direct
intercompany loan. Two of the most important advantages are as follows:

1. Certain countries apply different withholding-tax rates to interest paid to a foreign parent and
interest paid to a financial institutions. A cost saving in the form of lower taxes may bi available
with a back-to-back loan.
2. If currency controls are imposed, the govemment usually will permit the local subsidiary to
honor the amotization schedule of a loan from a major multinational bank; to stop payment
would hurt the nations credit rating. Conversely, local monetary authorities would have far
fewer reservations about not authorizing the repayment of an intercompany loan. In general,
back-to-back financing provides better protection than does a parent loan against expropriation
and/or exchange controls.

Some financial managers arguc that a back-to-back loan conveys anather benefit: the subsidiary
seems to have obtained credit from a major bank on its own, possibly enhancing its reputation.
However, this appearance is unlikely to be significant in the highly informed international financial
community.
The cost of a back-to-back loan are evaluated in the same way as any other financing method
(i.e., by considering relevant interest and tax rates and the likelihood of changes in currency value). To
see how these calculations should be made, assume that the parents opportunity cost of funds is 10%,
and the parents and affiliates marginal tax rates are 34% and 40%, respectively. Then, if the parent
earns 8% on its deposit, the bank charges 9% to lend dollars to the affiliate, and thr local currency
devalues by 11% during the course of the loan, the effective cost of this back-to-back equals.

Interest cost intrest income interest cost tax again on


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To parent to parent to subsidiary excange

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