International Business NB: 1-2 pages. Due by the end of the day today. Question

Question

International Business

NB: 1-2 pages. Due by the end of the day today.

Question 1 A:

While market-based hedging instruments can be used to offset or counter uncertainties in interest rates and exchange rates as they impact the income statement, balance sheet hedges require a different approach. Assume you are the CFO of Toyota trying to offset the balance sheet risks associated with Toyota’s $4.5 billion investment in Georgetown, Kentucky. Please explain how this risk would be offset by a combination of a 15-year Euro Dollar Bond with equal repayments in the last five years and a floating rate 10-year syndicated Euro-Dollar bank loan combined with an interest rate swap. Assume a fifteen-year straight-line amortization of the new Georgetown facility.

Question 1 B

Look at the JAL FX loss scenario in the Additional Text Readings where JAL lost as much as or more in FX than the $800 million value of the planes it was purchasing. Then calculate JAL’s cost if it had used a different type of hedge, borrowing US$ to buy U.S. government bonds that it then cashed as each plane was purchased. Generally one can borrow up to 95% of the value of U.S. government bonds with the borrowing cost normally about .25% or 25 basis points above the yield on the bonds. Assume that the yield on the bonds is 8% and that they borrow for the full 10 years noted in the case.

Explanation / Answer

Answer :-

1.) A.) Market-Based Hedging instruments can be used to Hedge uncertainties in interest rates and exchange rates as impact the income statement, balance sheet hedges require a different Approach. In this case we want to balance an asset with liabilities that minimize Toyotas net exposure. Such liabilities are in the form of bonds and bank loans but these must be reduced in proportion as the assets on the balance sheet are reduced over time. So we need to calculate the Annual Depreciation and apportion it between the bank loans and the bonds.

1.) B.) JAL FX case while the problem still involves a balance sheet hedge because planes are long-lived assets, the hedging problem is dynamic as the planes will be delivered and paid for in the future. Here the proper way to hedge is to borrow against US government bonds where the net costs of borrowing are very low and you can borrow up to 95% so the net FX exposure is quite low. Then as the planes are purchased you cash the bonds keeping the loan in place. The Hedging Cost will be 95% of the $800 million principle amount times 0.25% (Net spread) less 8% of the 5% net principle amount times 10 years. And we will compare this with what the forward exchange transaction cost to see which is better.

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