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FINA3020 Assignment3
FINA3020 Assignment3
FINA3020 Assignment3
Assignment 3
Due Date: 18 March 2024 (9:30am for FINA3020C or 2:30pm for FINA3020B)
Questions:
1. GBA Company wishes to raise USD5,000,000 with debt financing. The funds will be
repaid with interest in 1 year. The treasurer of GBA Company is considering three
sources:
If the company borrows in euros or British pounds, it will not cover the foreign exchange
risk; that is, it will change foreign currency for dollars at today’s spot rate and buy foreign
currency back 1 year later at the spot rate prevailing then. The GBA Company has no
operations in Europe.
A representative of GBA contacts a local academic to provide projections of the spot rates
1 year in the future. The academic comes up with the following table:
a. What is the expected interest rate cost for the loans in EUR and GBP? [2 marks]
b. What is the projected USD/GBP rate and USD/EUR rate for which the expected interest
costs would be the same for the three loans?
For EUR: We use the UIP equation
It's not necessarily a clear-cut decision. While the academic forecast suggests that
borrowing in Euros might have the lowest interest cost, it's important to consider that
these forecasts aren't always accurate. Additionally, the "break-even" rates calculated
earlier, which are based on market-driven forward rates, show a significant difference,
therefore it depends on whether you want to risk it or not.
Yes, if GBA generates cash flows in the UK and continental Europe, it might make sense
to consider borrowing in those respective currencies. Borrowing in the same currency as
where the cash flows originate from could serve as a natural hedge against currency
fluctuations, potentially reducing overall risk for the company.
2. In 1985, R.J. Reynolds (RJR for short) acquired Nabisco Brands and financed the deal
with a variety of financial instruments, including three dual-currency Eurobonds. The
first dual-currency bond, lead-managed by Nikko, raised JPY25 billion (which was
equivalent to USD105.5 million at the time of issue). Coupons were paid in yen, but the
required final principal payment was not JPY25 billion but USD115.956 million. The
coupon was
7.75%, even though a comparable fixed-rate Euroyen bond at that time carried only a
6.375% coupon. The actual 5-year forward rate at the time was around JPY/USD 200.
a. Given the “fat” coupon, is this bond necessarily a great deal for investors? [1 mark]
Because the final payment is less than the bond's face value, it isn't a good deal for the
investor.
This can be seen by multiplying USD115.956 million by the forward rate to find the
yen value of the final payment: USD115.956 million × JPY200/USD = JPY23.191
billion, which is less than JPY25 billion.
b. At maturity in August 1990, the spot exchange rate was JPY/USD 144. Was the bond
a good deal for investors assuming the position was unhedged?
Assuming the position was unhedged: USD 115.956 million x JPY 144/USD = JPY
16.698 billion
No, the bond was not a good deal for investors. When the bond matured in August
1990, investors received significantly less in yen than they would have if they had
sold the bond forward at the forward rate prevailing in August 1985. This substantial
loss occurred because the yen appreciated more than anticipated by the forward rate.
The "fat coupon" offered by the bond was unable to compensate for this significant
capital loss. Therefore, it's evident that it was not a favorable deal for them.
The internal rate of return on the bond is 6.48%, according to Excel's IRR command.
Therefore, if investors can hedge at the future rate of ¥200/$, the bond is a good
investment.
2- Suppose you are a U.S.-based investor, and you would like to diversify your stock
portfolio internationally. What advantages do ADRs offer you? Would it be wise to
restrict your international portfolio to only ADRs?
First, ADRs make it simple to access global markets without having to deal with foreign
exchanges directly. The investing process is made simpler because they are traded on
American marketplaces just like conventional equities. Furthermore, the fact that ADRs
are valued in US dollars helps lessen currency risk for investors in the US. This implies
that you won't need to be concerned about how currency fluctuations will impact the
profits on your investments. Moreover, investors benefit from a degree of familiarity and
transparency because ADRs are governed by U.S. securities legislation. Even though
ADRs have these advantages, it wouldn't be wise to restrict your foreign portfolio to just
ADRs. By doing this, you might limit your exposure to specific areas or industries not
represented by ADRs and potentially missing out on diversification and opportunities and
the potential for higher returns markets.
3. A U.S. institutional investor would like to purchase 10,000 shares of Lafarge. Lafarge is a
French firm that trades on the Paris Bourse, the London stock exchange, and the NYSE as
an ADR. At the NYSE, one depositary receipt is equivalent to one-fourth of a Lafarge
share. The U.S. investor asks its brokers to quote net prices, without any commissions, in
the three trading venues. There is no stamp tax in London on foreign shares listed there.
Compare the USD costs of purchasing 10,000 shares, or its equivalent, in New York,
London, and Paris.
NYSE
Based on the information given, the purchase cost in NYSE is 974800, 979338.6 in
London Stock Exchange, and 972408.5 in Paris Stock Exchange. Therefore, Considering
net prices without commissions, the U.S. investor would find the lowest purchase cost for
Lafarge shares on the New York Stock Exchange
Amount of TWD received by the investor : 3 015 000 –( 301500+904500) = 1 809 000
TWD