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GN Co, whose home currency is the dollar, has exported products to Europe for several years and all European customers pay on a credit basis in euros.
It now plans to invest in a European storage, packing and distribution network. The investment will cost €13m and is to be financed by equal amounts of equity and debt.
The debt finance will be provided by an immediate €6.5m loan note issue. The interest rate on the loan note issue is 8% per year, with interest being payable in euros on a six-monthly basis.
The equity finance will be an immediate rights issue in GN’s home country to raise $5m after issue costs of $300,000. GN’s current share price is $2.50 per share and the rights issue would be made at a 20% discount.
The spot exchange rate is $1 = €1.30. The six-month forward rate is $1 = €1.2876 and the 12-month forward rate is $1 = €1.2752.
Question
4. Which of the following is the correct procedure for hedging the first interest payment on the loan note?(Select your answer using the rectangular buttons)
A Step 1 Borrow an appropriate amount in euros now
Step 2 Convert the euro amount into dollars now
Step 3 Place the dollars on deposit
B Step 1 Borrow an appropriate amount in dollars now
Step 2 Place the dollars on deposit now
Step 3 Convert the dollars into euros in six months’ time
C Step 1 Borrow an appropriate amount in dollars now
Step 2 Convert the dollar amount into euros now
Step 3 Place the euros on deposit
D Step 1 Borrow an appropriate amount in euros now
Step 2 Place the euros on deposit now
Step 3 Convert the euros into dollars in six months’ timeAns is C option May I know how…?
C
They plan to invest
They are a US coStep 1 Borrow an appropriate amount in dollars now
Part of the finance is debt finance, a euro loan
The other equity is in dollars so the doesn’t need to be hedgedStep 2 Convert the dollar amount into euros now
Step 3 Place the euros on deposit
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