Chapter 18 Questions2018 (1)
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Chapter 18 Questions (20 pts) Answer the following questions related to the readings from Chapter 18. The questions are in BOLD so please make sure your answers are NOT in bold as it will make grading the assignment much easier for me.
1)
(4 pts) Explain the difference in the cost of financing with foreign currencies during a
strong-dollar period, versus a weak-dollar period for a U.S. firm.
The cost of financing with foreign currencies is lower when the US dollar is stronger and higher when it
is weaker. When the dollar is strong, it means that it can buy more of weaker foreign currencies. What
this means is, a US firm financing in foreign currency would need fewer dollars to buy the same amount
of the foreign currency. This would lower the cost financing. On the other side, when the US dollar is in a
weaker state it can now buy less of a foreign currency. So, in this case the firm would need more dollars
to buy the same amount of currency. This would effectively increase the cost of financing. 2)
(3 pts) Kerr, Inc., a major U.S. exporter of products to Japan, denominates its exports in
dollars and has no other international business. It can borrow dollars at 9 percent to
finance its operations or borrow yen at 3 percent. If it borrows yen, it will be exposed to
exchange rate risk. How can Kerr borrow yen and possibly reduce its economic exposure to
exchange rate risk?
One strategy Kerr could use would be to establish a plant in Japan to enable them access to cheap
financing at 3%. Then to reduce exchange rate risk the company could buy inputs in Japan and
manufacture the products in Japan. 3)
(3 pts) Katina, Inc., is a U.S. firm that plans to finance with bonds denominated in euros to
obtain a lower interest rate than is available on dollar-denominated bonds. What is the most
critical point in time when the exchange rate will have the greatest impact?
The most critical point in time when the exchange rate will have the greatest impact is maturity. This is because the principal will be paid back at maturity.
4)
(10 pts) Sambuka, Inc. can issue annual coupon bonds in either U.S. dollars or in Euros that
mature in three years. Dollar-denominated bonds would have a coupon rate of 5 percent;
Euro-denominated bonds would have a coupon rate of 4 percent. Assuming that Sambuka
can issue bonds worth $10,000,000 in US dollars or 8 million Euros, given that the current
exchange rate is $1.25/1 Euro.
a)
If the forecasted exchange rate for the Euro is $1.28/1 Euro for each of the next three
years what is the annual cost of financing for the Euro-denominated bonds? Which type
of bond should Sambuka issue?
8,000,000*4%= 320,000
320,000*1.28= 409,600
409,600/10,000,000= 0.04096 or 4.1%
The cost of financing for the Euro denominated bonds is ~4.1% which is less than the 5%
financing cost of the dollar denominated bonds so the Euro denominated bonds should be issued.
b)
If the forecasted exchange rate for the Euro is $1.21 for each of the next three years
what is the annual cost of financing for the Euro-denominated bonds? Which type of
bond should Sambuka issue?
8,000,000*4%= 320,000
320,000*1.21= 387,200
387200/10,000,000= 0.03872 or 3.872%
Since the dollar denominated bond is higher at 5% the company should issue Euro denominated bonds.
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