Reference no: EM132964445

Question - A U.S. corporation is considering whether to take advantage of low Japanese interest rates, and finance some of its U.S. operations by converting $100 million in outstanding dollar debt to yen-denominated debt via a currency swap. The debt maturity is 5 years and is in the form of 5-year zero-coupon bonds. U.S. bond yields are 3%/year, whereas yen bond yields are 0%/year. The U.S. corporation believes that the Bank of Japan's monetary policy will prevent the yen from appreciating and is consequently forecasting that the yen will still be at its current rate of 109 yen/dollar in five years. The U.S. marginal tax rate is 21%. All transactions and cash flows take place within the U.S. and affect only the corporation's U.S. taxes; the corporation pays no Japanese taxes.

Required -

a) What is the corporation's after-tax cost of dollar debt, in percent per year?

b) What is the corporation's expected after-tax cost of yen debt, in percent per year?

c) How many dollars (pre-tax) will the corporation have to pay in 5 years if it issues dollar debt?

d) How many yen (pre-tax) will the corporation have to pay in 5 years if it issues yen debt?

e) What is the break-even exchange rate in five years - i.e., the exchange rate that would make future yen obligations equal in value to future dollar obligations?

f) If the U.S. corporation assesses $/yen exchange rate volatility at 10% annualized, what is the probability that yen debt would end up being more expensive than dollar debt 5 years hence?