The Walt Disney Company’s

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The Walt Disney Company’s
Yen Financing

Motivations for Currency Swaps

1. Currency risk management

Match the currency exposure on the asset side with similar currency exposure on the liability side, or convert foreign currency earnings to domestic currency.

2. Arbitrage Profits based on comparative cost advantage

Cost
European Apples American Apples

Beliz1 ECU 0.75 dollars

Dan1.25 ECU 1.5 dollars
------------------------------------------------------------------- Beliz’s advantage0.25 ECU0.75 dollars

0.1875 dollarsvs. 0.75 dollars
0.25 ECUvs. 1.00 ECU

Assuming 1ECU = 0.75 dollars

Comparative advantage = 0.75 – 0.1875 = 0.5625 dollars, or, = 1.00 – 0.25 = 0.75 ECU
Beliz likes European apples and Dan likes American apples. Both like to eat three apples a day.

Without trading Beliz must spend 3ECU or 2.25 dollars
Without trading Dan must spend 4.5 dollars or 6 ECU

Beliz and Dan do an American/European Apple Swap

Beliz buys three American apples and Dan buys three European apples. They swap their fruits.

Beliz spends 3 X 0.75 dollars = 2.25 dollars or 3 ECU
Dan spends 3 X 1.25 ECU = 3.75 ECU or 2.8125 dollars

Dan pays 1 dollar (or 1.333 ECU) to Beliz

Beliz’s cost = 2.25 - 1.00 = 1.25 dollars or 1.666 ECU
Dan’s cost= 3.75 + 1.333 = 5.0833 ECU or 3.8125 dollars

Beliz saves 1 dollar (or 1.333 ECU) and Dan saves 0.6875 dollars (or 0.9166 ECU). Together they save 1.6875 dollars (or 2.25 ECU) which is equal to the comparative advantage per fruit of 0.5625 dollars (or 0.75 ECU) times 3 fruits.

Hedging Alternatives

1. Should Walt Disney Hedge (see Exhibit 4)

2. FX Forward Contracts

Available at low cost only until 2 year maturity (see Exhibit 5) due to the high bid-ask spread

Even if a quote is available, the dealers are unwilling to transact in any substantial size

3. Currency Futures and Options

Similar problems as those of FX forward contracts

4. Balance Sheet Hedge (without a swap)

Issue a yen term loan, or a yen bond. However, the Japanese market may not be ready. Walt Disney is a single-A rated company. The process is cumbersome requiring an underwriter, a “commissioned company,” and coordination with the “Bond Floatation Committee.”

French Utility’s Comparative Cost Advantage

ECUYen
Walt Disney (A) 9.256%7.61%

French Utility (AAA) 9.16%6.717%
-------------------------------------------------------------- French Utility’s 0.096%0.893%
advantage

Comparative advantage = 0.893% - 0.096% = 0.797%
Details

1. Walt Disney – ECU loan (Exhibit 6)

How does one get 78.499?

80 Million X 100.25% = 80.2 Million ECU
- (80 Million X 2%)
-$75,000

= 78.6 Million ECU - $75,000
= 78.6 Million ECU - 101,078.167 ECU
= 78.499 Million ECU

78.499 = 7.3/(1 + x) + 7.3/(1 +x)2 +…..+ 17.46/(1+x)10

x = 9.47%

Under semi-annual compounding, the YTM should equal 9.256%.

2. Walt Disney – yen loan

Yen loan has a front end fee of 0.75%, and has interest of 3.75% paid every six months (see the last two paragraphs of page 4). Hence,

100 - 0.75 =3.75/(1+x) + 3.75/(1+x)2 +...+ 103.75/(1+x)20

x = 3.804%
Since we are already using semi-annual compounding,
the YTM equals 2 X 3.804% = 7.61%

3. French Utility - ECU loan
See ECU- Mar 95 maturity loan in Exhibit 8. The YTM with annual compounding is 9.37%. Hence, the YTM with semi-annual compounding should be 9.16%.

4. French Utility – yen loan
See yen - Jan 95 maturity loan in Exhibit 8. The YTM with annual compounding is 6.83%. Hence, the YTM with semi-annual compounding should be 6.717% Walt Disney’s Cost of Yen Financing (Before and After the Swap)

French utility needs ECU Debt in...
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