Multinational Finance, EIE 2005/06, problem set - V
Operating exposure management
Question 1
Suppose an English parent owes USD 5,000,000 to its French affiliate. The timing of this payment can be changed by
up to 90 days in either direction. The following effective annualized after-tax dollar borrowing and lending rates in
England and France are given:
Borrowing Lending
England 4.0% 3.2%
France 3.6% 3.0%
Should the parent lead or lag the payment? Consider each alternative:
a. Both parent and affiliate have excess funds;
b. French affiliate has excess funds, whereas English parent needs to borrow;
c. French affiliate is borrowing funds, while parent has excess funds;
d. Both parent and affiliate have to borrow funds.
Question 2
Consider a company that uses risk-sharing agreements and allows its foreign distributors to make a payment in their
local currency. For that year, central exchange rate is set at USD 0.7150/AUD. The company agrees to price all
contracts at this exchange rate as long as the current spot rate on order day is within ą5% of the central rate. If the spot
rate falls outside this range but it is still within ą10% of central exchange rate, the company will share equally the
difference between the new spot rate and the neutral boundary with the contractor.
a. Calculate the boundary exchange rates of the neutral and risk-sharing zones.
b. Suppose that on the order day exchange rate is USD 0.6850/AUD and the merchandise s price in U.S. dollar is
USD 7,500. What is the price in Australian dollar to the foreign distributor?
c. What will be the price in AUD if exchange rate is USD 0.8600/AUD?
Interest rate exposure management
Question 3
Eurocurrency deposit interest rates are given.
Maturity (days) USD %p.a. CHF %p.a.
30 3.5400 4.5000
90 3.7800 4.4375
180 4.0200 4.2500
360 4.6500 4.0000
a. Calculate the forward spot interest rate for the second half 180-day period of the year for the Euro-dollar
deposits.
b. Calculate the forward spot interest rate for the second 90-day period of the year for the Swiss franc.
Question 4
Mr. A. and Mr. B. seek funding at the lowest possible cost. The following rate structure is available:
Mr. A. Mr. B.
Cost of fixed-rate borrowing 10% 13%
Cost of floating-rate borrowing LIBOR+0.5% LIBOR+1%
a. In what type of borrowing does Mr. A. have a comparative advantage?
b. If the swap were arranged, what is the maximum savings?
c. Describe a transaction that would generate maximum savings divided equally between the two parties.
Question 5
ABC, of Britain has a pound debt of GBP 5,000,000 at fixed 9.5%p.a., but it has strong preference for floating-rate
pound debt. The best alternative it can obtain is LIBOR+2.0%. XYZ, of U.S. wishes to finance exports to Britain with
GBP 3,000,000 of pound-denominated fixed-rate debt for six months but it cannot afford to pay more than 12.0%. It can
obtain a fixed interest rate at no less than 13.5% or floating interest rate at LIBOR+2%. Assume that ABC has strong
bargaining position, so it can negotiate the best deal possible. Transaction costs are zero and exchange rates do not
change.
a. How can ABC and XYZ help one another via an interest rate swap? Propose and describe a suitable
transaction.
b. What are the interest savings by each party over the six-month period of the swap?
Multinational Finance, EIE 2005/06, problem set - V
Question 6
XYZ has just purchased the following interest rate cap agreement:
Maturity: 2 years
Strike rate: 7.00%
Reference rate: 3-month U.S. dollar LIBOR
Total periods: 8 (4 per year)
Notional principal: USD 3,600,000
Premium: 66 basis points (0.66%)
Fixed borrowing rate: 8%
a. Calculate quarterly cash payments and annualized interest costs (interest payment outflow, cap cash payment
inflow, cap premium payment outflow). The actual 3-month U.S. dollar LIBOR rate is 7.25%
b. Graphically depict valuation profile of the interest rate cap.
Question 7 (homework 4)
Company A. wishes to borrow fixed-rate dollars which can be obtain at 13%p.a. It is also offered floating interest rate at
LIBOR+1.5%. Company B. prefers floating-rate debt which is opened at LIBOR+0.5%. It can also obtain fixed interest
rate at 11%p.a.
a. In what type of borrowing does A. have a comparative advantage? Explain in detail.
b. If the swap were arranged, what is the maximum savings?
c. Describe a transaction that would generate maximum savings divided equally between the two parties.