International Finance

PROBLEMS

1. Alpha and Beta Companies can borrow for a five-year term at the following rates:

Alpha Beta

Moody’s credit rating Aa Baa

Fixed-rate borrowing cost 10.5% 12.0%

Floating-rate borrowing cost LIBOR LIBOR + 1%

a. Calculate the quality spread differential (QSD).

b. Develop an interest rate swap in which both Alpha and Beta have an equal cost savings in their borrowing costs. Assume Alpha desires floating-rate debt and Beta desires fixed-rate debt. No swap bank is involved in this transaction.

2. Do problem 1 over again, this time assuming more realistically that a swap bank is involved as an intermediary. Assume the swap bank is quoting five-year dollar interest rate swaps at 10.7% - 10.8% against LIBOR flat.

3. Explain the following statement: “Exposure is the regression coefficient.”

4. Read the following case and answer the corresponding questions below. Please limit your total response to no more than 3 pages.

Case: The Walt Disney Company’s Yen Financing

Questions:

1. Should Disney hedge its yen royalty cash flow? Why or why not?

2. What hedging alternatives are available to Disney’s treasurer?

3. The AAA French utility has an absolute borrowing cost advantage over Disney in either currency. Why would it consider swapping obligations with Disney?