4) (10 pts) Sambuka, Inc. can issue annual coupon bonds in either U.S. dollars o

Question

4) (10 pts) Sambuka, Inc. can issue annual coupon bonds in either U.S. dollars or in Euros that mature in three years. Dollar-denominated bonds would have a coupon rate of 5 percent; Euro-denominated bonds would have a coupon rate of 4 percent. Assuming that Sambuka can issue bonds worth $10,000,000 in US dollars or 8 million Euros, given that the current exchange rate is $1.25/1 Euro. a) If the forecasted exchange rate for the Euro is $1.28/1 Euro for each of the next three years what is the annual cost of financing for the Euro-denominated bonds? Which type of bond should Sambuka issue?

Explanation / Answer

Year 1 Year 2 Year3 Payment in Euros 320000 320000 320000 Exchange rate $/Euro 1.28 1.28 1.28 Payment in $ 409600 409600 409600 Cost of financing for Euro bonds = 409600/10000000 = 4.10% As the cost of the dollar denominated bond is higher at 5%, Sambuka should issue Euro denominated bonds.

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