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The Walt Disney Company’s Yen Financing

2012/6/3

Case Study in COMM 328

Q1. Yes, Walt Disney Company should hedge its yen royalty cash flow for the following reasons: JPY royalties grows fast: The Walt Disney Company has been receiving yen royalties for several revenues generated by Tokyo Disneyland. During the fiscal year 1984, yen royalty receipts had been just over 8 billion yen and this figure is expected to increase 10% to 20% yearly over the next few years. Given that the expenses incurred by the company would be paid in dollars, Walt Disney Company would not be able to escape from the foreign exchange risk that it might face. Yen/Dollar rate fluctuation: The current spot rate of 248 yen/dollar represented almost 8% depreciation in the value of the yen from 229.70 just over a year ago. But it has appreciated in the quarter since then. From Chart 1 and Chart 2, we can see that the U.S. inflation has exceeded Japanese inflation for the past 5 years, which indicates the future depreciation of dollar against Yen. Furthermore, the forward rate (Exhibit 5) also indicates the same depreciation of dollar. Given the recent depreciation of the yen against the dollar, it is increasingly difficult to forecast the future value of the yen. Considering the long term trend, maybe it does not need to concern the depreciation of the JPY, but if the appreciation of JPY is lower than expectation will also hurt Disney’s plan. Therefore, it can’t be more precise to arrange comprehensively. How much should be hedged and over what time frame Disney Company receives Yen royalties of 8 billion with expected yearly growth rate of 10%-20% and has its large expenses in dollars. It needs the hedge of currency risk at least 8 billion. Although from Exhibit 3, it is shown that Disney Company has some yen term loan. Through calculation, the yen term loan which will be due of 2/1/93 has 12.5 billion yen outstanding and 765 million semiannual yen (1.53 billion annual yen) principal payments, as at 31 March, 1985. There is another $50 million due on March 1989 which the company swapped into approximately 12 billion yen liability. This would require Disney to pay 7.4% of 12 billion which is equivalent to 0.888 billion which is really a small number compared with the 8 billion yen. As for the term of hedge, Disney should think of hedging techniques for the maximum swap term: 10 years.

Q2. Advantages and Disadvantages of Hedging Techniques: Futures Market Advantages: As futures contracts are traded in a central market, it has a higher level of liquidity. There is a pool of market participants available and this increases the probability of being able to buy or sell futures. Disadvantages: Once in the contract, there is a legal obligation to follow through till the end. As such, if currency movements were to 2

Case Study in COMM 328

move in the opposite direction from what has been predicted, then these favorable movements would have to be foregone. Also, since the futures contract has several agreed upon terms, such as contract size and hedging, it is relatively rigid and perfect hedging may be impossible. In the case, liquid markets for future contracts existed only for maturities of two years or less. The term couldn’t hedge the long-term JPY royalties well. Options Market In this case, the dollar yen options purchased by Disney could allow them to buy dollars against yen at a predetermined rate or they could also exercise their put options allowing them to sell yen for dollars at a predetermined rate. Advantages: It provides the right, but not the obligation, to exercise the option on or before the expiration date, in the case of an American option. This provides a limit to the potential losses but no limit to any potential gains. Also, the use of options in hedging provides greater flexibility as compared to forwards or futures contracts. Disadvantages: Due to its greater flexibility, options often require a premium amount and...
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