Sambuka, Inc. can issue bonds in either U.S. dollars or in Swiss francs. Dollar-
ID: 2697245 • Letter: S
Question
Sambuka, Inc. can issue bonds in either U.S. dollars or in Swiss francs. Dollar-denominated bonds would have a coupon rate of 12 percent; Swiss franc-denominated bonds would have a coupon rate of 10 percent. Assuming that Sambuka can issue bonds worth $10,000,000 in either currency, that the current exchange rate of the Swiss franc is $.70, and that the forecasted exchange rate of the franc in each of the next three years is $.75, what is the annual cost of financing for the franc-denominated bonds? Which type of bond should Sambuka issue?
Sambuka, Inc. can issue bonds in either U.S. dollars or in Swiss francs. Dollar-denominated bonds would have a coupon rate of 12 percent; Swiss franc-denominated bonds would have a coupon rate of 10 percent. Assuming that Sambuka can issue bonds worth $10,000,000 in either currency, that the current exchange rate of the Swiss franc is $.70, and that the forecasted exchange rate of the franc in each of the next three years is $.75, what is the annual cost of financing for the franc-denominated bonds? Which type of bond should Sambuka issue?
Explanation / Answer
Hi,
Please find the answer as follows:
If Swiss Franc denominated bonds are issued by Sambuka, Bonds would have a face value of = 10000000/.70 = SF14285714
Year 1
SF Payment = SF 1714286
Exchange Rate = .75
Payments in $ = $ 1285715
Year 2
SF Payment = SF 1714286
Exchange Rate = .75
Payments in $ = $1285715
Year 3
SF Payment = SF 16000000
Exchange Rate = .75
Payments in $ = $ 12000000
The annual cost of financing is 14.92% for the franc denominated bonds.
The annual cost of franc denominated bonds (14.92%) is less than the annual cost of financing of dollar denominated bonds (15%). Therefore, Sambuka should issue the franc denominated bonds.
Thanks.
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