problem: Ashton Bishop is the debt manager for World Telephone, which needs €3.33 billion Euro financing for its operations. Bishop is considering the choice between issuance of debt denominated in:
Euros (€), or
United State dollars, accompanied by a combined interest rate and currency swap.
Describe one risk World would suppose by entering into the combined interest rate and currency swap.
Bishop believes that issuing the United State dollar debt & entering into the swap can lower World's cost of debt by 45 basis points. Immediately after selling the debt issue, World would swap the UNITED STATE dollar payments for Euro payments throughout the maturity of the debt. She supposes 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 three (3) year tenor Euro/UNITED STATE Dollar currency and interest rate swap.
Exhibit 1
World Telephone Debt Details
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Characteristic
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Euro Currency Debt
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UNITED STATE Dollar Currency Debt
|
|
Par value
|
€3.33 billion
|
$3 billion
|
|
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
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Spot currency exchange rate
|
$0.90 per Euro ($0.90/€1.00)
|
|
3-year tenor Euro/UNITED STATE Dollar fixed interest rates
|
5.80% Euro/7.30% UNITED STATE Dollar
|