Reference no: EM13940874

Question 1
A U.S. firm holds an asset in Great Britain and faces the following scenario:

where,
P* = Pound sterling price of the asset held by the U.S. firm
P = Dollar price of the same asset

a) What is the expected value of the investment in U.S. dollars?
b) What is operational exposure? Discuss the factors that may influence the size of a company's operating exposure?
c) Discuss the ways in which a firm may manage its operating exposure. Illustrate your answer with appropriate examples.
d) Critically evaluate whether or not a firm should hedge its currency exposure.

Question 2
a) Consider 8.5% Swiss franc/U.S. dollar dual-currency bonds that pay $800 at maturity per SF1,000 of par value. What is the implicit SF/$ exchange rate at maturity? Will the investor be better or worse off at maturity if the actual SF/$ exchange rate is SF1.35/$1.00?
b) Compare and contrast the major types of international bond market instruments. Your answer should include a summary of the distinguishing characteristics of each instrument you mention.

Question 3
Company A is a AAA-rated company, and it needs $10,000,000 to finance floating rate Eurodollar term loans. It is considering issuing five-year floating-rate notes (FRNs) indexed to LIBOR. Alternatively, it could issue five-year fixed-rate Eurodollar bonds at 10.50 percent. The FRNs make the most sense for Company A, since it would be using a floating-rate liability to finance a floating-rate asset.
Company B is a BBB-rated U.S. company. It needs $ 10,000,000 to finance a capital expenditure with a five-year economic life. It can issue five-year fixed-rate bonds at a rate of 12 percent in the U.S. bond market. Alternatively, it can issue five-year FRNs at LIBOR plus 0.5 percent. The fixed-rate debt makes the most sense for Company B because it locks in a financing cost.
An intermediate bank will change a fee of $10,000 from both companies to manage the SWAP arrangement.

a) Explain what an interest rate SWAP is and critically appraise its use.(
b) From the information given above, develop an interest rate swap in which both company A and B have an equal saving in their borrowing costs.