In May 1988, Walt Disney Productions sold to Japanese investors a 20-year stream of projected yen royalties from Tokyo Disneyland. The present value of that stream of royalties, discounted at 6% (the return required by the Japanese investors), was ¥93 billion. Disney took the yen proceeds from the sale, converted them to dollars, and invested the dollars in bonds yielding 10%.
According to Disney's chief financial offi- cer, Gary Wilson, ‘‘In effect, we got money at a 6% discount rate, reinvested it at 10%, and hedged our royalty stream against yen fluctuations-all in one transaction.''
a. At the time of the sale, the exchange rate was ¥124 = $1. What dollar amount did Disney realize from the sale of its yen proceeds?
b. Demonstrate the equivalence between Walt Disney's transaction and a currency swap. (Hint: A diagram would help.)
c. Comment on Gary Wilson's statement. Did Disney achieve the equivalent of a free lunch through its transaction?