Final exam FIN.docx - 1 Your firm has just issued five-year...

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1. Your firm has just issued five-year floating-rate notes indexed to six-month U.S. dollar LIBOR plus 1/4%. What is the amount of the first coupon payment your firm will pay per U.S. $1,000 of face value, if six-month LIBOR is currently 7.2%? Solution: 0.5 x (.072 + .0025) x $1,000 = $37.25. 1. On the Tokyo Stock Exchange, Honda Motor Company stock closed at ¥2,907 per share on Monday, June 6, 2016. Honda trades as and ADR on the NYSE. One underlying Honda share equals one ADR. On June 6, 2016, the ¥/$ spot exchange rate was ¥107.57/$1.00. a. At this exchange rate, what is the no-arbitrage U.S. dollar price of one ADR? b. By comparison, Honda ADRs traded at $27.18. Do you think an arbitrage opportunity exists? Solution: a. The no-arbitrage ADR U.S. dollar price is: ¥2,907 ÷ 107.57 = $27.02. b. It is unlikely that an arbitrage opportunity exists after transaction costs. Additionally, the slight difference in prices is likely accounted for by a difference in information contained in prices since the Tokyo Stock Exchange closes several hours before the NYSE. 1. Alpha and Beta Companies can borrow for a five-year term at the following rates: Alpha Beta Moody’s credit rating Aa Baa Fixed-rate borrowing cost 10.5% 12.0% Floating-rate borrowing cost LIBOR LIBOR + 1% a. Calculate the quality spread differential (QSD). b. Develop an interest rate swap in which both Alpha and Beta have an equal cost savings in their borrowing costs. Assume Alpha desires floating-rate debt and Beta desires fixed-rate debt. No swap bank is involved in this transaction. Solution: a. The QSD = (12.0% - 10.5%) minus (LIBOR + 1% - LIBOR) = .5%. b. Alpha needs to issue fixed-rate debt at 10.5% and Beta needs to issue floating rate-debt at LIBOR + 1%. Alpha needs to pay LIBOR to Beta. Beta needs to pay 10.75% to Alpha. If this is done, Alpha’s floating-rate all-in-cost is: 10.5% + LIBOR - 10.75% = LIBOR - .25%, a .25% savings over issuing floating-rate debt on its own. Beta’s fixed-rate all-in-cost is: LIBOR+ 1% + 10.75% - LIBOR = 11.75%, a .25% savings over issuing fixed-rate debt. 2. Do problem 1 over again, this time assuming more realistically that a swap bank is involved as an intermediary. Assume the swap bank is quoting five-year dollar interest rate swaps at 10.7% - 10.8% against LIBOR flat. Solution: Alpha will issue fixed-rate debt at 10.5% and Beta will issue floating rate-debt at LIBOR + 1%. Alpha will receive 10.7% from the swap bank and pay it LIBOR. Beta will pay 10.8% to the swap bank and receive from it LIBOR. If this is done, Alpha’s floating-rate all-in-cost is: 10.5% + LIBOR - 10.7% = LIBOR - . 20%, a .20% savings over issuing floating-rate debt on its own. Beta’s fixed-rate all-in-cost is: LIBOR+ 1% + 10.8% - LIBOR = 11.8%, a .20% savings over issuing fixed-rate debt. 1. Ford is a US based MNC with AAA credit. Sony is a Japanese firm with AAA credit. Ford wants to borrow Yen 150 million for three years and Sony wants to borrow $1,200,000 for three years. The spot exchange rate is Yen 125 = $1.00 a swap bank makes the following quotes for 3-year swaps and AAA-rated firms against USD LIBOR.

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