Ashton Bishop is the debt Manager for World Telephone, which needs €3.33 billion Euro financing for its operations. Bishop is considering the choice between issuance of debt denominated in:
Euros (€), or U.S. dollars, accompanied by a combined interest rate and currency swap.
a. Explain one risk World would assume by entering into the combined interest rate and currency swap.
Bishop believes that issuing the U.S.-dollar debt and entering into the swap can lower World's cost of debt by 45 basis points. Immediately after selling the debt issue, World would swap the U.S. dollar payments for Euro payments throughout the maturity of the debt. She assumes a constant currency exchange rate throughout the tenor of the swap.
Exhibit 1 gives details for the two alternative debt issues. Exhibit 2 provides current information about spot currency exchange rates and the 3-year tenor Euro/U.S. Dollar currency and interest rate swap.
b. Show the notional principal and interest payment cash flows of the combined interest rate and currency swap.
Note: Your response should show both the correct currency ($ or €) and amount for each cash flow.
Answer problem b in the template provided.
Template for problem b
c. State whether or not World would reduce its borrowing cost by issuing the debt denominated in U.S. dollars, accompanied by the combined interest rate and currency swap. Justify your response with onereason.