BUS330: International Finance

Post-Topic09 (Chapter 09):

Currency and Interest Rate Swaps

Students should study about the Currency and Interest Rate Swaps (chapter 09)
thoroughly to prepare Final Exam. As part of final exam preparation, students should
solve following post-topic09 problems by employing their understandings/concepts
that have been developed through pre-topic09 and topic09 sessions.

Post-Topic09 Problems

2. Bond offering decision Australian Motor Industries has no foreign currency cash
flows. It plans to either issue a bond denominated in euros with a fixed interest rate,
or a bond denominated in Australian dollars with a floating interest rate. It estimates
its periodic dollar cash flows for each bond. Which bond do you think would have
greater uncertainty surrounding these future dollar cash flows? Explain.

4. Exchange rate effects Bunnings Warehouse is an Australian company that plans

to finance with bonds denominated in Thai baht to obtain a lower interest rate than is
available on Australian dollar-denominated bonds. What is the most critical point in
time when the exchange rate will have the greatest impact?

5. Financing decision Biopharm Australia has attempted to capitalise on new

opportunities to expand in South Asia. The production costs in most South Asian
countries are very low, often less than one-fourth of the cost in India and
Bangladesh. Furthermore, there is a strong demand for drugs in South Asia.
Biopharm Australia penetrated South Asia by purchasing a 60 per cent stake in
Square Pharmaceutical, a Bangladesh company that produces drugs.

a. Should Biopharm Australia finance its investment in the Bangladesh company by

borrowing Australian dollars from an Australian bank that would then be converted
into Bangladesh taka, or by borrowing Bangladeshi taka from a local Bangladeshi
bank? What information do you need to know to answer this question?

b. How can borrowing Bangladeshi taka locally from a Bangladeshi bank reduce the
exposure of Biopharm Australia to exchange rate risk?

c. How can borrowing Bangladeshi taka locally from a Bangladeshi bank reduce the
exposure of Biopharm Australia to political risk caused by government regulations?

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7. Swap agreement Boral Ltd is a well-known Australian company that needs to
borrow 10 million Malaysian ringgit to support a new business in Malaysia. However,
it cannot obtain financing from Malaysian banks because it is not yet established
within Malaysia. It decides to issue Australian dollar-denominated debt (at par value)
in Australia, for which it will pay an annual coupon rate of 10 per cent. It then will
convert the Australian dollar proceeds from the debt issue into Malaysian ringgit at
the prevailing spot rate (the prevailing spot rate is 1 ringgit = A$0.35). Over each of
the next three years, it plans to use the revenue in ringgit from the new business in
Malaysia to make its annual debt payment. Boral Ltd engages in a currency swap in
which it will convert ringgit to Australian dollars at an exchange rate of A$0.35 per
ringgit at the end of each of the next three years. How many Australian dollars must
be borrowed initially to support the new business in Malaysia? How many ringgit
should Boral Ltd specify in the swap agreement that it will swap over each of the
next three years in exchange for Australian dollars so that it can make its annual
coupon payments to the Australian creditors?

9. Interest rate swaps; floating-for-fixed BHP Billiton of Australia holds a three-

year A$5 million loan on a floating rate (LIBOR + 2% per annum), with payment due
semi-annually. The company has just made an interest payment today (the next
payment is due in six months) and also forecasts that the interest rate is about to
rise. The company also has an opportunity to swap its floating rate payments for
fixed payments of 7per cent per annum. The swap contract period is two years and
the LIBOR is currently 4 per cent per annum in the market.

a. How much of a profit or loss does BHP make if it enters into a swap contract today
and the LIBOR rises at the rate of 50 basis points per six-month period starting from
tomorrow?

b. If the LIBOR falls by 25 basis points per six-month period starting from tomorrow,
how much of a profit or loss does BHP make from the swap contract?

Assumptions Values
Notional principal (A$) 5,000,000
LIBOR, per annum 4.000%
Spread paid over LIBOR, per annum 2.000%
Swap rate, to pay fixed, per annum 7.000%

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10. Financing and the currency swap decision Specsavers Australia is
considering a project in which it will export special contact lenses to China. It expects
that it will receive 1 million Chinese yuan after taxes at the end of each year for the
next four years, and after that time its business in China will end as its special patent
will be terminated. The yuan’s spot rate is presently A$.20. The Australian annual
risk-free interest rate is 6 per cent; while China’s annual risk-free interest rate is 11
per cent. Interest rate parity exists. Specsavers Australia uses the one-year forward
rate as a predictor of the exchange rate in one year. Specsavers Australia also
presumes that the exchange rates in each of the years 2 through 4 will also change
by the same percentage as it predicts for year 1. Specsavers Australia searches for
a company with which it can swap yuan for Australian dollars over each of the next
four years. Anhui Bangshida Co. is an importer of Chinese products. It is willing to
take the 1 million yuan per year from Specsavers Australia and will provide
Specsavers Australia with Australian dollars at an exchange rate of A$.17 per yuan.
Ignore tax effects. Specsavers Australia would use 10.92% as the required return for
this project.

a. Determine whether the net present value (NPV) of this project if Specsavers
Australia engages in the currency swap.

b. Determine the NPV of this project if Specsavers Australia does not hedge the
future cash flows.

12. Financing and exchange rate risk Bragbags Co. (an Australian company)
presently serves as a distributor of products by purchasing them from other
Australian companies and selling them in Europe. It wants to purchase a
manufacturer in Thailand that could produce similar products at a low cost (due to
low labour costs in Thailand) and export the products to Europe. The operating
expenses would be denominated in Thai currency (the baht). The products would be
invoiced in euros. If Bragbags Co. can acquire a manufacturer, it will discontinue its
existing distributor business. If Bragbags Co. purchases a company in Thailand, it
expects that its revenue might not be sufficient to cover its operating expenses
during the first eight years. It will need to borrow funds for an eight-year term to
ensure that it has enough funds to pay all of its operating expenses in Thailand. It
can borrow funds denominated in Australian dollars, Thai baht or euros. Assuming
that its financing decision will be primarily intended to minimise its exposure to
exchange rate risk, which currency should it borrow? Briefly explain.

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13. Financing and exchange rate risk JB Hi Fi Co. has a subsidiary in Thailand
that produces computer components. The subsidiary sells the components to
manufacturers in Australia. The components are invoiced in Australian dollars. JB Hi
Fi pays employees of the subsidiary in Thai baht and makes a large monthly lease
payment in Thai baht. JB Hi Fi financed the investment in the Thai subsidiary by
borrowing Australian dollars from an Australian bank. It has no other international
business.

a. Given the conditions, is JB Hi Fi affected favourably, unfavourably or not at all by

depreciation of the Thai baht? Briefly explain.

b. Assume that interest rates in Thailand declined recently, so JB Hi Fi subsidiary

considers obtaining a new loan in Thai baht. JB Hi Fi would use the proceeds to pay
off its existing loan from an Australian bank. Will this form of financing increase,
reduce or have no impact on its economic exposure to exchange rate movements?
Briefly explain.