Suppose that the date is December 29,2006. You are working for a
Boston-based multinational company that has a strong credit rating.
Your boss, the CFO, tells you that the company needs to borrow $25
million for two years, and asks you to find offers from the investment
,banks that the company usually deals with. You check and find two
.offers. Your company can issue a 2-year, fixed-rate, US dollar
denominated Eurobond in the amount of US$ 25 million. The bond
would have a coupon rate of 6.5% and would pay annual coupons.
The principal amount would be due on the last day of the second year.
The fees for placing the bond would be $200,000 and would be taken
from the proceeds of the bond issue. Your company can also issue a
euro denominated Eurobond. It would be in the amount of € 20
million. It would also be a two year, fixed-rate bond with the entire
principal amount due on the last day of the second year. The bond
would have a coupon rate of 5% and would pay annual coupons. The
fees for placing the bond would be € 150,000 and would be taken
from the proceeds of the bond issue. Assume that on December 29,
2006 the exchange rate of the euro is US$ 1.33 = €1.
Your company can issue either of these bonds on January 3,2007.
a. What would be the annual pretax interest rate (adjusted for fees)
that your company would pay if it chooses to issue the bond in
dollars? The bond in euros? Show your method.
b. How much can the euro strengthen relative to the US dollar,
for the exchange-rate-adjusted cost of these two sources of
financing to be equal? Assume that one year from the date of
issue, the euro would be trading at 1 euro = $1.36.
c. Suppose that your company issues the euro denominated bond,
and that the euro strengthens versus the US dollar by ten cents
each year. That is, suppose that the exchange rate is US$ 1.43
= €l after the first yeaL US I 1.53 after the ~econdyear. \Vhs~
would be the annual cost in donars, expressed as a percentage
rate, of borrowing the euros?