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1、BUFN 770 International InvestmentsThe Walt Disney Companys Yen FinancingThe Walt Disney Companys Yen FinancingIssueThe Walt Disney Company is a diversified international company which operated entertainment and recreational complexes, produced motion picture and television features, developed commun
2、ity real estate projects, and sold consumer products. In July 1984, Disney was concerned about possible foreign-exchange exposure due to future yen royalty receipts from Tokyo Disneyland. The royalty receipts had been just over 8 billion during fiscal 1984 and were expected to grow very fast over th
3、e next few years. Since yen depreciated against dollar recently, Rolf Anderson, the director of finance at Disney, was considering various ways of hedging this exposure. In the meantime, Borrowings and debt ratio increase a lot in at the end of fiscal 1984 due to the acquisition of Arvida and its th
4、e expenditure for the repurchase of 4.2 million shares of the companys common stock. Therefore, Disney needed a solution that can hedge the foreign-exchange exposure and reduce its short-term debt at the same time. Therere four different ways of hedging this exposure(1) foreign-exchange (FX) options
5、, futures, and forwards (2) swap out of existing dollar debt into a yen liability (3) ten-year term loan (4) swap out of ten-year ECU Eurobonds into a yen liability.Alternatives(1) Foreign-exchange options, futures, and forwards Mr. Anderson could sell FX options, futures and forwards to hedge the e
6、xchange risk created by the increasing yen royalty receipts if the yen continued to depreciate in the years ahead. However, liquid markets for options and futures contracts exist only for maturities of two years or less. And Mr. Anderson probably needed to hedge for more than two year. Therefore, op
7、tions and futures should be ruled out.Disney could also use the forward exchange market to lock its dollar value of its yen royalties. However, long-dated outright forward rates (Exhibit 5) were priced very conservatively by banks, and the bid-offer spreads tended to open quite wide. Moreover, Banks
8、 are usually not eager to take on the risk of changes in future level of spot exchange rates. Thus, it would not be a wise choice for Disney to hedge by selling yen forwards.(2) Swapping out of existing dollar debt into yen liabilityDisney could enter into a Dollar-Yen swap, which converts more of i
9、ts existing dollar debt into a yen liability. However, this is not an ideal option. First, since Disneys Eurodollar note issues matured in one to four years, this type of hedge would be short term. Besides, attractive yen swap rates for maturities less than four years were had to find. In addition,
10、this arrangement would not provide any additional cash, thus Disney couldnt reduce the short-term debt on the balance sheet right away. Moreover, Disney was unable to issue longer maturity Eurodollar debt issue because of Disneys recent Eurodollar note issue and the companys temporarily high debt ra
11、tio. Finally, in the Euroyen bond market, Disney was also ineligible to issue Euroyen bonds under the current Japanese Ministry of Finance guidelines.(3) Ten-year term loanDisney could also hedge the future yen royalty receipts by creating a yen liability through a term loan from a Japanese bank at
12、the Japanese long-term prime rate. Under this alternative, Disney would borrow a 15 billion ten-year bullet loan, with principal repaid at final maturity, which required interest of 7.50% paid semiannually and front-end fees of 0.75%.As Table 1 shows, the cash inflow net of front-end fees of 0.75% a
13、t time 0 is 15,000M*(1-0.75%) =14,887.50 M. Afterwards, the cash outflows would be 15,000*7.5%/2 = 562.5 from year 0.5 to year 9.5. Finally, the principal of 15,000 and interest expenses of 562.5 would be both paid at year 10. The IRR of these cash flows was 3.8042%, which means that the effective a
14、nnualized cost of borrowing Yen for Disney would be (1+3.8042%)2-1=7.75% under semi-annual compounding.We also calculate the hedged amount as the percentage of royalty receipts in the following years. We assume that the Royalty receipt grows per half year from 8 billion in 1984 at a rate in Table 1.
15、 As a result, the coverage ratio become lower and lower afterwards except at year 10, indicating that Disney would face larger exchange rate risk in the later year. The advantages of this alternative:1) Disney could exchange the initial yen proceeds for dollars at the spot rate to reduce its short-t
16、erm borrowings.2) No default riskDisney doesnt have to worry about the default risk of its counterparty which is a bank compared to forward hedge or swap hedge.3) Disney can hedge a portion of its royalty receipts in the future.The disadvantages of this alternative:1) The borrowing cost of 7.75% is higher than that of Euro-yen swap, which will be discussed later.2) The payment pattern of this alternative remains the same every year, while the yen royalties would gr
