Essay about McDonald’s Corporation’s British Pound Exposure

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Chapter 9 Mini Case – McDonald’s Corporation’s British Pound Exposure

1. How does the cross currency swap effectively hedge the three primary exposures McDonalds has relative to its British subsidiary. In general, cross currency swap is a contract to swap currencies of debt service obligation (Eiteman, Stonehill, & Moffett, p. 245). For example, McDonalds needs to swap pound denominated fixed interest rate and adopt floating interest rate from the US headquarter. The need to enter into swap agreement depends on the expected floating rate. If the company expects the floating rate to decrease, then it is appropriate to swap fixed for floating. As a result, McDonalds will pay less for the interest payment because of the cross currency…show more content…
By entering into seven years currency swap, the company would not need to worry about the increasing cost of British pound and the company can comfortably reduce its holding of foreign currency by paying pounds and receiving dollars. The purpose of this hedging is to lock in the dollar and avoid the increasing cost of pound in the seven years period. This course of action the company takes will ensure any outstanding debt will be declined in the anticipated date. 2. How does the cross-currency swap hedge the long-term equity exposure in the foreign subsidiary? A cross-currency swap is said to be an agreement between two parties to exchange payments and principal on loans denominated in two different currencies (Eiteman, Stonehill, & Moffett, p. 333). As presented in the McDonald's Pound Exposure case, the interest payments of a loan are exchanged for an equally valued loan using a different currency. In order to hedge the long-term equity exposure in the foreign subsidiary, the cash inflows of the parent company, in this case McDonald's, must be examined. For instance, the British subsidiary has equity capital, which in turn becomes a pound-denominated asset for the parent company. Additionally, McDonald's also provides intra-company debt and receives royalties from the British subsidiary in British pounds. Having said this, in order to offset the pounds that
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