Quiz 2

Quiz – 2 (Financial Engineering – Prof. Mahendra Mehta)

You are running a global car company (eg: Ford). You are the CFO of the company. Your CEO wants you make a presentation to the board suggesting ways to lower the company’s cost of funding. The company has access to the capital markets. Background Capital Markets information is as follows:

Govt bond yield	3-month maturity	10 –year Maturity
US	0	3.5
EUR	1	4
JPY	0.5	1.5

The chief economist of your company believes that Yen and Euro are likely to weaken over 10 years. One choice is to issue fixed rate 10 year debt via corporate debt issuance.

Corporate spreads in US = 1%, EUR = 1.5% & in JPY = 2%.

Q1 – What rate can you issue 10-year fixed rate in each country?

Q2 – Fixed-for-floating 10 year spreads are: US = 10bp; EUR = 20bp; JPY = 50bp. If you swap your fixed rate bond to floating, what is your floating rate coupon in US, EUR and JPY?

Q3 – assume that short rates stay fixed for 10 years, what is the cost of debt in US, EUR and JPY?

Q4 – At the end of 10 year, your chief economist forecasts are as following: USD is weaker by 20%, JPY is weaker by 10%, EUR is same. If you issue debt now in these currencies, in 10 years time, you will have to pay back what % in real terms of USD, JPY and EUR notional?

Q5 – Give the specific funding cost and rank order the following choices in each of the 3 currencies: 10 year fixed rate debt; 10 year floating rate debt; foreign currency bond

Q6 – Given the 3 possibilities (Fixed 10 year, floating 10 year, foreign currency) which combination of financing structures do you suggest

Q7 – What are the risks of your recommendation? (All types of risk including but not limited to Business vs Financial mismatches)?

Q8 – If there were no financial intermediation, which option above would not be possible?

Q9 – Why do you think corporate spreads are so different in USD, EUR and JPY? Why is the fix to floating spreads so different in each country?

Q10 – Now assume that markets are liquid and all the options presented above are feasible. Who benefits and who loses from the various options?

Q11 – Do you think this type of financial engineering is useful to society at large? Why?

Q12 – Can you think of other innovative ideas to lower the funding cost of the company?