Sambuka, Inc., can issue bonds either in U.S dollars or in Swiss francs. Dollar-
ID: 2757177 • Letter: S
Question
Sambuka, Inc., can issue bonds either in U.S dollars or in Swiss francs. Dollar- denominated bonds would have a coupon rate of 15 percent; Swiss franc-denominated bonds would haev a coupon rate of 12 percent. Assuming that Sambuka can issue bonds worth $10 million 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 3 years is $.75, what is the annual cost of financing for the franc-denominated bonds? Which type of bond should Sambuka issue?
Explanation / Answer
Answer
Particulars
Bond issue
Amount
Currency
US Dollars
Swiss Franks
Current exchange rate of Swiss franc to $
0.7
Total Bond issue size
a
10000000
7000000
10000000*0.7
Coupon rate
b
15%
12%
Annual Interest cost (a*b)
c
1500000
840000
Particulars
Amount
Annual Interest cost of Swiss franc denominated bond issue ( in Swiss franc terms)
d
840000
Forecasted exchange rate of Swiss franc to $
e
0.75
Annual Interest cost of Swiss franc denominated bond issue (in $ terms)
(d/e)
1120000
Answer 1 : Annual cost of financing for the franc-denominated bonds is 840,000 Swiss franc or $ 1,120,000.
Answer 2 : Annual cost of financing for the franc-denominated bonds is $ 1,120,000 whereas Annual cost of financing for the dollar-denominated bonds is 1,500,000. So annual cost of financing for the franc-denominated bonds is less than annual cost of financing for dollar-denominated bonds.
So, Sambuka should issue franc-denominated bonds.
Particulars
Bond issue
Amount
Currency
US Dollars
Swiss Franks
Current exchange rate of Swiss franc to $
0.7
Total Bond issue size
a
10000000
7000000
10000000*0.7
Coupon rate
b
15%
12%
Annual Interest cost (a*b)
c
1500000
840000
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