Hhhh Essay

3290 words - 14 pages

Case Analysis

International Financial Markets Peter MacKay

February 21, 2002 Ryan Case Mark Duncanson Christopher McRoberts Jenn Nabb Rob Norr

Due to past depreciation in the yen, Disney has decided to consider hedging future yen royalties paid by Tokyo Disneyland. Disney can enter into a currency swap to capitalize on its comparative advantage to borrowing in its local debt market and therefore obtain interest rates more favorable than the French utility could hope to obtain. Each party then swaps the currency they could receive at lower rates and share in the overall benefit. Disney may also wish to hedge long-term foreign exchange exposures since future fluctuations of a ...view middle of the document...

Companies are able to lock in long-term exchange rates, often beyond what banks are willing to quote, through the repayment of debt service obligations denominated in a foreign currency. This flexibility is valuable to firms with foreign currency revenue streams. Swaps create value for a company when structured in a way where the total cost is lower for both parties. The companies can then use the funds saved through swaps for further investments in positive NPV projects. The following risks are inherent to the Industrial Bank of Japan: Interest Rate Risk—This risk results from unfavorable changes in interest rates before the dealer has the chance to identify and secure the counter party (other side) of the currency swap.

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Basis Risk—This comes from the floating rates of the two counter parties whom are pegged to differing indices. If the indexes are not correlated, the swap bank could be faced with a shortage of floating rate funds when passing from one side to the other. The bank’s spread could shrink or they could even incur a loss. Exchange Rate Risk—This risk relates to the risks the swap bank manages from fluctuating exchange rates from the time the bank accepts one side of the swap to the time the bank finds another interested counter party. Any exchange rate changes are focused on the swap bank. Credit or Default Risk—Swap banks also face this type of risk as companies go out of business or have bad times and fail to pay their obligations. Therefore the swap bank would have to fulfill the obligation of the defaulting party to the counter party. It is expected that the maturity dates and the size of the principal sums needed by the counter parties are going to differ widely so finding an exact match of needs in the swap is difficult; therefore, a mismatch risk is always present and must be managed. Sovereign Risk—Countries can, at any time, impose exchange restrictions on their currency so this risk is always present. Changes could result in rendering the currency swap unprofitable or impossible. Undesirable Hedging Techniques Among the options Disney has to hedge its risk, there are several undesirable options, which it should avoid. First, Disney could use foreign exchange options, futures, and forwards to hedge its risk. Typically, these contracts exist only for maturities of 2 years or less; thus, going against a Disney long-term hedging strategy. Second, foreign exchange forward contracts could be used. However, these instruments have the same short maturities and are considered by banks as part of its total exposure to Disney, and tie up valuable credit lines. Third, Disney could swap out existing dollar debt into Yen liability. This short-term strategy was done earlier as Disney issued Eurodollar not to mature from 1 to 4 years. This is unattractive because of the scarcity of Yen swap rates for maturities less than 4 years. In addition, this option would not provide for any additional cash and Disney is interested in...

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