Finance

Knowledge resource 1265 views 2 replies

Pooja Jajoo

29 Points Joined August 2011

It is May 1985 and UAL, Inc., parent of United Airlines, needs to borrow $500 million to finance the purchase of Hertz. You are Assistant Treasurer and must make a recommendation about the choice between borrowing in the USA in U. S. Dollars or in Japan in Yen (¥). As background, UAL, Inc. owns United Airlines and Westin Hotels. It is buying Hertz from RCA. United Airlines will generate about 80% of the UAL revenue and the remainder will be evenly split between Hertz and Westin. United Airlines, Hertz, and Westin Hotels are worldwide service companies that generate revenue in many countries and currencies, mainly in the U.S., Canada, Latin America, and Europe. The Treasurer considers this to be a “No Brainer” or easy choice.

If the loan is in U. S. Dollars in the USA, company policy requires the use of a specific investment banker. This firm estimates terms of the USA loan as follows: An interest rate of 11% per year paid semi-annually in December and June for 10 years. The principal of $500 million would be repaid at the end of the 10-years. There would be a one-time underwriting fee of approximately 0.5% to be paid when the funds are received.

A leading Japanese bank is offering a loan with the interest and principal denominated in Yen. The interest rate will be 5% and there are no upfront fees. Both loans require interest payments in December and in June. The entire principal is due in June 1995.

In May 1985, the exchange rate fluctuated between 250 and 252 yen to the dollar. For convenience, use 250 ¥ to the $ as the exchange rate.

Instructions: As an assistant treasurer at that time, you are required to make a recommendation specifying which alternative of the two is better; (b) explain and discuss why your alternative is wise.

You can find historical currency rates at https://www.oanda.com/convert/fxhistory.

Please do suggest!!

Replies (2)

rahul

Finance Manager

91 Points Joined January 2011

the anwer to your question will largely be dependent on the then available exchange rate. However i went to the link privided by you but the exvhange rate availbale is 1990 onwards. Also the rate during that time was around 130yen to dollar.

If the company is a US based compny, taking loan in yen would require the company to hedge its currency wid yen which will add up to the Yen interest rate (hedging cost). This cost will be dependent on the then availble forwrd premiun or discount.

As i saw the cureency rates btwn 1990 to 1999 the currency was fairly stable and hence the forwrd prenium/ discount would have been low due to less volatility. Hence, yen dollar loan looks better than the US dollar loan.

Also you should check the economic environment prevailing at tht time.

You will have to take into account that Japan is a country depending mainly on exports of their products so chances are that they will keep their at low levels to increase exports. if you compare the rates now, over a period of time japan has appriciated its currency alot and this would have been very harmfull for the US based copany in the current scenario.

Nonetheless, i feel Yen would have been a better option as you mentioned the company has revenues in different currrencies which would help it to mitigate currency losses if any had or will happn.

rahul

Finance Manager

91 Points Joined January 2011

Also you should check the economic environment prevailing at tht time.

Nonetheless, i feel Yen would have been a better option as you mentioned the company has revenues in different currrencies which would help it to mitigate currency losses if any had or will happn.