SMALL BUSINESS DILEMMA
Solve the following problem:
Long-Term Financing Decision by the Sports Exports Company
Producing footballs in the United States and exporting them to the United Kingdom. The exports are denominated in pounds, which has continually exposed the firm to exchange rate risk. It is now considering a new form of expansion where it would sell specialty sporting goods in the United States. If it pursues this U.S. project, it will need to borrow long-term funds. The dollar-denominated debt has an interest rate that is slightly lower than the pound-denominated debt.
1. Jim Logan, owner of the Sports Exports Company, needs to determine whether dollar-denominated debt or pound-denominated debt would be most appropriate for financing this expansion, if he does expand. He is leaning toward financing the U.S. project with dollar denominated debt since his goal is to avoid exchange rate risk. Is there any reason why he should consider using pound-denominated debt to reduce exchange rate risk?
2. Assume that Logan decides to finance his proposed U.S. business with dollar-denominated debt, if he does implement the U.S. business idea. How could he use a currency swap along with the debt to reduce the firm's exposure to exchange rate risk.