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Question: A company in the USA needs a loan of 10 million Euros to finance its upcoming operations in Germany. However, it cannot take a loan from a German bank because it is not yet established in Europe.
The company issues US Dollar -denominated debt (at par value) in USA, with an annual coupon rate of 10%. After it will convert the dollar proceeds from the debt issue into Euros at the current spot rate $1.12.
The company plans to use the revenue in euros from the business transactions for loan repayments during the next three years. Hence, the company engages in a currency swap contract to exchange euros to dollars for an exchange rate of $1.12 at the end of each of the next 3 years.
How many dollars must be borrowed initially to operate the business in Germany? How many euros should the company specify in the swap agreement that it will swap over each of the next three years in exchange for dollars, in order to make its annual coupon payments to the U.S. creditors?
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