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Evaluation of Transaction and currency swaps.
In May 1988, Walt Disney Productions sold to Japanese investors a 20 year stream of projected yen royalties from Tokyo Disneyland. The present value of that stream of royalties, discounted at 6% (the return required by the Japanese investors), was ¥93 billion. Disney took the yen proceeds, converted them to dollars, and invested the dollars in bonds yielding 10%. According to Disney's CFO, "In effect, we got money at a 6% discount rate, reinvested it at 10%, and hedged our royalty stream against yen fluctuations - all in one transaction."
a. At the time of the sale, the exchange rate was 124 = $1. What dollar amount did Disney realize from the sale of its yen proceeds?
b. Demonstrate the equivalence between Disney's transaction and a currency swap. (Hint: a diagram would help)
c. Did Disney achieve the equivalent of a free lunch through its transaction?
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