9. Grupo Modelo, a brewery out of Mexico that exports such well-known varieties

Question

9.   Grupo Modelo, a brewery out of Mexico that exports such well-known varieties of beer including Corona, Modelo and Pacifico, is Mexican by incorporation. However, the company evaluates all business results, including financing costs, in U.S. dollars. The company needs to borrow $10,000,000 or the foreign currency equivalent for four years. For all issues, interest is payable once per year, at the end of the year. Available alternatives are:

•     Sell Japanese yen bonds at par yielding 3% per annum. The current exchange rate is ¥106/$, and the yen is expected to strengthen against the dollar by 2% per annum.      

•     Sell euro-denominated bonds at par yielding 7% per annum. The current exchange rate is $1.1960/€, and the euro is expected to weaken against the dollar by 2% per annum.                                                             

•     Sell U.S. dollar bonds at par yielding 5% per annum.

a.   What is the expected effective interest rate per year (p.a.) for each loan?

b.         Which one would you recommend and why?   

Explanation / Answer

a. Effective interest rate for Japanese bonds = [(1+Japanese bond yield) / (1+exchange rate appreciation) - 1] * 100%

= [(1+3%) / (1-2%) - 1] * 100%

= 5.10%

Effective interest rate for Eurobonds = [(1+Euro bond yield) / (1+exchange rate appreciation) - 1] * 100%

= [(1+7%) / (1+2%) - 1] * 100%

= 4.90%

b. Therefore, euro bond is the better option as its effective interest rate is lower.

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