4. Cray Research in the U.S. has recently decided to construct a wholly owned manufacturing facility in Bonn, Germany, to manufacture super computers for sale in the European Union. The plant is expected to cost 5,500,000, and to take about one year to complete. The plant is to be financed over its economic life of cight years. The borrowing capacity created by this capital expenditure is $2,900,000; the remainder of the plant will be equity financed. Cray Research is not well known in Germany or international bond market; consequently, it would have to pay 7 percent per annum to borrow euros, whereas the normal borrowing rate in the euro zone for well-known firms of equivalent risk is 6 percent. Alternatively, Cray Research can borrow dollars in the U.S. at a rate of 8 percent. The exchange rate has been forecast to be 0.7519 per UD dollar in one year. The Max Planck Institute in Germany has a mirror-image situation and needs $2,900,000 to finance a capital expenditure of one of its U.S. subsidiaries. It finds that it must pay a 9 percent fixed rate in the United States for dollars, whereas it can borrow euros at 6 percent. (a) Can you determine if it is mutually beneficial to set up a currency swap between Cray Research and the Max Planck Institute in Germany? Explain. 12+2 marks] (b) If your answer is "yes" to part (a), use a diagram to illustrate the operations of this currency swap, i.e. the flows of funds from the commencement of the currency swap to the maturity of the swap. Explain your diagram. 12+2+2 marks] (e) Determine the (re-)exchange of (1) principal sums in the first year; (ii) the annual debt service payments in the first seven years, and (ii) the principal sums and the final debt service payments at maturity. Show all workings 12+2+2 marks] (d) Assume that euro appreciates 1% against the US dollar annually from the second year onwards. () How does the curo appreciation affect your answers to part (c)? Explain. (i) Discuss what possible risks Cray 304 Research and the Max Planck Institute have to face over the life of the currency swap. 12+2 marks] 4. Cray Research in the U.S. has recently decided to construct a wholly owned manufacturing facility in Bonn, Germany, to manufacture super computers for sale in the European Union. The plant is expected to cost 5,500,000, and to take about one year to complete. The plant is to be financed over its economic life of cight years. The borrowing capacity created by this capital expenditure is $2,900,000; the remainder of the plant will be equity financed. Cray Research is not well known in Germany or international bond market; consequently, it would have to pay 7 percent per annum to borrow euros, whereas the normal borrowing rate in the euro zone for well-known firms of equivalent risk is 6 percent. Alternatively, Cray Research can borrow dollars in the U.S. at a rate of 8 percent. The exchange rate has been forecast to be 0.7519 per UD dollar in one year. The Max Planck Institute in Germany has a mirror-image situation and needs $2,900,000 to finance a capital expenditure of one of its U.S. subsidiaries. It finds that it must pay a 9 percent fixed rate in the United States for dollars, whereas it can borrow euros at 6 percent. (a) Can you determine if it is mutually beneficial to set up a currency swap between Cray Research and the Max Planck Institute in Germany? Explain. 12+2 marks] (b) If your answer is "yes" to part (a), use a diagram to illustrate the operations of this currency swap, i.e. the flows of funds from the commencement of the currency swap to the maturity of the swap. Explain your diagram. 12+2+2 marks] (e) Determine the (re-)exchange of (1) principal sums in the first year; (ii) the annual debt service payments in the first seven years, and (ii) the principal sums and the final debt service payments at maturity. Show all workings 12+2+2 marks] (d) Assume that euro appreciates 1% against the US dollar annually from the second year onwards. () How does the curo appreciation affect your answers to part (c)? Explain. (i) Discuss what possible risks Cray 304 Research and the Max Planck Institute have to face over the life of the currency swap. 12+2 marks]
