Chapter 9 Mini Case – McDonald’s Corporation’s British Pound Exposure
1. How does the cross currency swap effectively hedge the three primary exposures McDonalds has relative to its British subsidiary. In general, cross currency swap is a contract to swap currencies of debt service obligation (Eiteman, Stonehill, & Moffett, p. 245). For example, McDonalds needs to swap pound denominated fixed interest rate and adopt floating interest rate from the US headquarter. The need to enter into swap agreement depends on the expected floating rate. If the company expects the floating rate to decrease, then it is appropriate to swap fixed for floating. As a result, McDonalds will pay less for the interest payment because of the cross currency swap. In addition, the swap allows the company to pay pounds and receive dollars in the seven years period. This is the hedging strategy the company uses to avoid the increasing cost of British pounds. Currently, McDonald’s parent company has three different pound-denominated exposures from the operation of British subsidiary. The first one is the equity capital which is a pound denominated asset. The second one is the debt loaned to the British subsidiary which carries a fixed interest of 5.30% per annum. The third one is the fixed percentage of gross sales in royalties to the parent companies. All these exposures lead to great deal of problem for McDonalds as the company has been hedging by entering into a cross-currency U.S dollar/British pound sterling swap. In regard of the loan made to the British subsidiary, the company has to pay fixed interest rate as high as 5.30%. However, currency swaps can minimize the rate that the company supposes to pay. There are couple advantages of the currency swap which McDonalds is currently using. One of the advantages is reducing the amount of monthly payment. Entering the currency swap allows McDonalds to swap away fixed interest rate for floating interest rate with the expectation of...
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