a) Mabindisa Ltd can issue 3-year bonds in either UK Pounds or Swiss Francs. Pounddenominated bonds would have a coupon rate of 15 percent; Swiss Franc-denominated bonds would have a coupon rate of 12 percent. Assume that Shumba can issue bonds worth £15 000 000 in either currency, that the current exchange rate of the Swiss Franc is £0.47, and that the forecasted exchange rate of the Franc in each of the next three years is £0.50. What will the annual cost of financing for the franc-denominated bonds be? Which type of bond should Shumba issue? (16) b) Induna Ltd has just agreed to a long-term deal in which it will export products to Japan. It needs funds to finance the production of the products that it will export. The products will be denominated in pounds. The prevailing UK long-term interest rate is 9 percent versus 3 percent in Japan. Assume that interest rate parity exists and that Induna Ltd believes that the international Fisher effect holds. i. Should Induna Ltd finance its production with yen and leave itself open to exchange rate risk? Explain. (3) ii. Should Induna Ltd finance its production with yen and simultaneously engage in forward contracts to hedge its exposure to exchange rate risk? (3) iii. How could Induna Ltd achieve low-cost financing while eliminating its exposure to exchange rate risk? (3) 2.1 Given the following information which financing method has the lowest interest cost? How much interest savings do you make by using the financing method with the lowest interest cost? [3] Loan Bankers’ Acceptance Amount R3 500 000 R3 500 000 Term 180 days 180 days Rate: Prime + 3.5% Banker’s Acceptance rate + 3.5% 9%+3.5% 7.9%+3.5% 2.1 eThekwini, Breweries of KwaZulu Natal, South Africa, has received an order for 10 000 cartons of beer from Alicante Importers of Alicante, Spain. The beer will be exported to Spain under the terms of a letter of credit issued by a Madrid bank on behalf of Alicante Importers. The letter of credit specifies that the face value of the shipment, US$720 000, will be paid 90 days later, after the Madrid bank accepts a draft drawn by eThekwini Breweries in accordance with the terms of the letter of credit. The current discount rate on a three-month banker’s acceptance is 8% per annum, and eThekwini Breweries estimates its weighted average cost of capital to be 20% per annum. 2 The commission for selling a banker’s acceptance in the discount market is 1.2% of the face amount. How much cash will eThekwini Breweries receive from the sale if it holds the acceptance until maturity? Do you recommend that eThekwini Breweries hold the acceptance until maturity, or discount it at once in the U.S. banker’s acceptance market? [7]
a) Mabindisa Ltd can issue 3-year bonds in either UK Pounds or Swiss Francs. Pound
denominated bonds would have a coupon rate of 15 percent; Swiss Franc-denominated
bonds would have a coupon rate of 12 percent. Assume that Shumba can issue bonds worth
£15 000 000 in either currency, that the current exchange rate of the Swiss Franc is £0.47,
and that the forecasted exchange rate of the Franc in each of the next three years is £0.50.
What will the annual cost of financing for the franc-denominated bonds be? Which type of
bond should Shumba issue? (16)
b) Induna Ltd has just agreed to a long-term deal in which it will export products to Japan. It
needs funds to finance the production of the products that it will export. The products will be
denominated in pounds. The prevailing UK long-term interest rate is 9 percent versus 3
percent in Japan. Assume that interest rate parity exists and that Induna Ltd believes that
the international Fisher effect holds.
i. Should Induna Ltd finance its production with yen and leave itself open to exchange
rate risk? Explain. (3)
ii. Should Induna Ltd finance its production with yen and simultaneously engage in
forward contracts to hedge its exposure to exchange rate risk? (3)
iii. How could Induna Ltd achieve low-cost financing while eliminating its exposure to
exchange rate risk? (3)
2.1 Given the following information which financing method has the lowest interest cost? How
much interest savings do you make by using the financing method with the lowest interest
cost? [3]
Loan Bankers’ Acceptance
Amount R3 500 000 R3 500 000
Term 180 days 180 days
Rate: Prime + 3.5% Banker’s Acceptance rate + 3.5%
9%+3.5% 7.9%+3.5%
2.1 eThekwini, Breweries of KwaZulu Natal, South Africa, has received an order for 10 000
cartons of beer from Alicante Importers of Alicante, Spain. The beer will be exported to Spain
under the terms of a letter of credit issued by a Madrid bank on behalf of Alicante Importers.
The letter of credit specifies that the face value of the shipment, US$720 000, will be paid 90
days later, after the Madrid bank accepts a draft drawn by eThekwini Breweries in accordance
with the terms of the letter of credit.
The current discount rate on a three-month banker’s acceptance is 8% per annum, and
eThekwini Breweries estimates its weighted average cost of capital to be 20% per annum.
2
The commission for selling a banker’s acceptance in the discount market is 1.2% of the face
amount.
How much cash will eThekwini Breweries receive from the sale if it holds the acceptance until
maturity? Do you recommend that eThekwini Breweries hold the acceptance until maturity, or
discount it at once in the U.S. banker’s acceptance market?
[7]
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