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ANALYTICAL APPLICATION 1
Bond Financing Analysis
ALTEC Inc. can issue bonds in either U.S. dollars or in Swiss francs. Dollar-denominated bonds would have a coupon rate of 15%; Swiss franc-denominated bonds would have a coupon rate of 12%. Assuming that ALTEC can issue bonds worth $10,000,000 in either currency, that the current exchange rate of the Swiss franc is $0.70, and that the forecasted exchange rate of the franc in each of the next 3 years is $0.75, what is the annual cost of financing for the franc-denominated bonds? Which type of bond should ALTEC issue?
ANALYTICAL APPLICATION 2
LEXCO Co. just agreed to a long-term deal in which it will export products to Japan. It needs funds to finance the production of the products that it will export. The products will be denominated in dollars. The prevailing U.S. long-term interest rate is 9% versus 3% in Japan. Assume that interest rate parity exists and that LEXCO believes that the international Fisher effect holds.
a. Should LEXCO finance its production with yen and leave itself open to the exchange rate risk? Explain.
b. Should LEXCO finance its production with yen and simultaneously engage in forward contracts to hedge its exposure to exchange rate risk?
c. How could LEXCO achieve low-cost financing while eliminating its exposure to exchange rate risk?
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The company's weighted cost of capital (WACC)
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