The Walt Disney company is based in Burbank, California and is a diversified international company. It is well known for its business divisions in entertainment motion picture, TV, consumer products as well as various real estate projects. In 1984, Disney and its subsidiaries posted outstanding results, as consolidated revenue increased by almost 27% to $1.7 billion and net income increased 5% to $97.8 million. In addition, Disney has also grown through acquisitions: assets have increased 15% to $2.7 billion in 1984. In this case, we attempt to solve Disney’s dilemma with Tokyo Disneyland. Tokyo Disneyland opened in April 1983 and Disney has been receiving period royalty receipts in exchange for use of its brand. The problem is that while the royalty receipts are denominated in Yen, the Yen has been experiencing a trend of depreciation, which erodes the receipts’ values. Disney has begun work with Goldman to figure out the best way to hedge the exposure, as well as to acquire the cheapest cost of financing. Our analysis suggests that Disney should accept the method proposed by Goldman Sachs, where it would issue an ECU-denominated bond and then enter into a currency swap. This would lower the cost of borrowing. Details of our analysis are presented in the rest of case. Introduction
As indicated previously, the chief problem for Disney is how to hedge its exposure to a depreciating yen, which would decrease the value of the royalty receipts. As indicated in the case, in 1984 the spot Yen/$ rate is 248, which is almost an 8% depreciation from just a year ago. To make matters worse, the receipts are expected to grow at 10%-20% per year over the next few years, which would further increase Disney’s currency risk. There are numerous methods a company can hedge currency risk, such as through FX forwards, futures and swaps. In particular, we will explore Goldman Sachs’ proposed method way of entering into a foreign currency swap. This would create a Yen liability, which would allow Disney to pay out its Yen receipts and not worry about their depreciating value. Before we discuss the currency swap, let’s first walk through all the options Disney has at its disposal. Disney’s Options
While there are many different methods of hedging, we should look into the cheapest option. We will look into methods such as 1) futures/options, 2) forwards, 3) swap, 4) bank loan and, finally, 5) the combination of an ECU bond issuance & a subsequent ECU/Yen Swap proposed by Goldman Sachs. 1) Futures/Options: FX futures and options are the conventional methods of hedging, since they are market-priced and have high liquidity. The values of these futures and options contracts would theoretically offset gains & losses of the Yen royalty receipts and thus hedge currency risk. Unfortunately, according to the case, the liquid options and futures contracts only existed for maturities of two years or less. This would not work out for Disney, which would need hedging for receipts beyond just two years. 2) Forwards: The other method to hedge would be forwards. Forward options are not exchange-traded and are thus much less liquid. This can be observed via the Bid/Offer chart in the case, which provides rates for Yen Long-Dated FX Forwards. The illiquidity can be seen through the wide Bid-Ask offer spread, especially in longer maturities (e.g. spot spread is 90 basis points, versus 460 basis points for 5-Year contract). Clearly, Forwards suffer the same liquidity problem as Futures/Options: only short-term maturities have acceptable rates, but Disney needs medium to long term hedges. Not to mention, FX Forwards would be perceived by banks as risky and thus tie up Disney’s credit lines, which are needed for daily operations. 3) Foreign-Currency Swap (Swap Only): On the surface, this would work in Disney’s favor because it can be customized to cater to Disney’s needs (e.g....
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