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26 Apr 2019

Given the following: US Dollars Swiss Francs Firm LMN 10 pct. 7 pct. Firm XYZ 8 pct. 6 pct. The above borrowing rates represent the borrowing rates the firms can obtain for a five year fixed rate debt issue in U.S. dollars or Swiss francs. Suppose XYZ wishes to borrow Swiss francs and LMN wishes to borrow U.S. dollars. LMN demands a 10 pct cost of borrowing . First step is for XYZ to borrow $1000 at its 8 percent rate. Using a swap demonstrate, explain how the borrowing costs of each company could be reduced. Assume the spot exchange rate of 2 Swiss francs per dollar. EXPLAIN IN DETAIL PLEASE

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Irving HeathcoteLv2

29 Apr 2019

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Question 3 a) Explain what risks must be considered by multinational corporations (MNCs) when deciding their long-term financing strategy, and discuss how these risks may be managed. [13 per cent] b) James Inc is based in the USA but has a subsidiary in Switzerland. James Inc wishes to obtain a loan of 71 million euros for three years. A French company, Anton Cie, that has some operations in the USA wishes to obtain a US dollar loan of $100 million, also for three years. The current exchange rate is 0.71 euro = $1. James Inc has been offered a dollar loan at 5% and a euro loan at 3.0%. Anton Cie has been offered a dollar loan at 5.5% and a euro loan at 2.5%. Show how both companies can achieve cheaper foreign loans by entering into a fixed rate currency swap, and discuss the factors that both parties should consider before deciding to enter into the swap arrangement. [12 per cent]

Question 4 a) Discuss the reasons why multinational corporations may prefer to borrow a foreign currency rather than the home currency. What are the main criteria to be considered in deciding which currency, or currencies, to borrow? [11 per cent] b) Moffett plc is a UK-based firm that needs Â£500,000. The company is considering one-year financing with Swiss francs because the annual interest rate would be 1.5 per cent versus 5 percent in the United Kingdom. Moffett has no business in Switzerland and does not plan to cover its exposure. It is anticipated that the Swiss franc will appreciate over the coming year by either 6 per cent, 4 per cent, or 2 per cent, with equal probability of each occurrence. On the basis of this information, determine the probability distribution of the effective financing rate if Moffett decides to finance with Swiss francs and advise the company whether it should do so. [7 per cent] c) A multinational corporation is considering borrowing a portfolio of Japanese yen and US dollars to finance its operations. The following information is available concerning the mean effective financing rate of the two currencies:

	US dollar	Yen
Mean effective financing rate	2.5%	1.5%
Standard deviation of effective financing rate	0.05	0.07

Correlation coefficient of effective financing rates for US$ and Yen (0.23)

Calculate the mean effective rate on a portfolio of funds financed 60% by US dollars and 40% by Japanese yen. Calculate also the variance and standard deviation of the portfolio. [7 per cent]

5. Ashton Bishop is the debt manager for World Telephone, which needs â¬3.33 billion Euro financing for its operations. Bishop is considering the choice between issuance of debt denominated in:

ï· Euros (â¬), or

ï· U.S. dollars, accompanied by a combined interest rate and currency swap.

a. Explain one risk World would assume by entering into the combined interest rate and currency swap.

Bishop believes that issuing the U.S.-dollar debt and entering into the swap can lower Worldâs cost of debt by 45 basis points. Immediately after selling the debt issue, World would swap the U.S. dollar payments for Euro payments throughout the maturity of the debt. She assumes a constant currency exchange rate throughout the tenor of the swap.

Exhibit 1 gives details for the two alternative debt issues. Exhibit 2 provides current information about spot currency exchange rates and the 3-year tenor Euro/U.S. Dollar currency and interest rate swap.

b. Show the notional principal and interest payment cash flows of the combined interest rate and currency swap. Note: Your response should show both the correct currency ($ or â¬) and amount for each cash flow.

Answer problem b in the template provided.

c. State whether or not World would reduce its borrowing cost by issuing the debt denominated in U.S. dollars, accompanied by the combined interest rate and currency swap. Justify your response with one reason.

Exhibit 1

World Telephone Debt Details

Chracteristics Euro Currency Debt US Dollar Currency Debt

par value EUR 3.33billion $3billion

term to maturity 3 years 3 years

fixed interest rate 6.25% 7.75%

interest payment annual annual

Exhibit 2

Currency Exchange rate and swap information

Spot currency exchange rate $0.90 per Euro ($0.90/EUR 1.00)

3-year tenor Euro/US Dollar fixed interest rates 5.80% Euro /7.30% US Dollar

Citrus Products Inc. is a medium-sized producer of citrus juice drinks with groves in Indian River County, Florida. Until now, the company has confined its operations and sales to the United States; but its CEO, George Gaynor, wants to expand into the Pacific Rim. The first step is to set up sales subsidiaries in Japan and Australia, then to set up a production plant in Japan, and finally to distribute the product throughout the Pacific Rim. The firmâs financial manager, Ruth Schmidt, is enthusiastic about the plan, but she worries about the implications of the foreign expansion on the firmâs financial management process. She has asked you, the firms most recently hired financial analyst, to develop a 1-hour tut0rial package that explains the basics of multinational financial management. The tut0rial will be presented at the next board of directors meeting. To get you started, Schmidt has given you the following list of questions.

a. What is a multinational corporation? Why do firms expand into other countries?

b. What are the five major factors that distinguish multinational financial management from financial management as practiced by a purely domestic firm?

c. Consider the following illustrative exchange rates:

U.S. Dollars Required to Buy One Unit of Foreign Currency

Japanese yen 0.009

Australian dollar 0.650

1. Are these currency prices direct quotations or indirect quotations?

2. Calculate the indirect quotations for yen and Australian dollars.

3. What is a cross rate? Calculate the two cross rates between yen and Australian dollars.

4. Assume that Citrus Products can produce a liter of orange juice and ship it to Japan for $1 75. If the firm wants a 50% markup on the product, what should the orange juice sell for in Japan?

5. Now assume that Citrus Products begins producing the same liter of orange juice in Japan. The product costs 250 yen to produce and ship to Australia, where it can be sold for 6 Australian dollars. What is the U.S. dollar profit on the sale?

6. What is exchange rate risk?

d. Briefly describe the current international monetary system. What are the different types of exchange rate systems?

e. What is the difference between spot rates and forward rates? When is the forward rate at a premium to the spot rate? When is it at a discount?

f. What is interest rate parity? Currently, you can exchange 1 yen for 0 0095 U.S. dollar in the 30-dayforward market, and the risk-free rate on 30-day securities is 4% in both Japan and the United States. Does interest rate parity hold? If not, which securities offer the highest expected return?

g. What is purchasing power parity (PPP)? If grapefruit juice costs $2 a liter in the United States and purchasing power parity holds, what should be the price of grapefruit juice in Australia?

h. What effect does relative inflation have on interest rates and exchange rates?

i. 1. Briefly explain the three major types of international credit markets.

2. Briefly explain how ADRs work.

j. What is the effect of multinational operations on capital budgeting decisions?

k. To what extent do average capital structures vary across different countries?