5. Ashton Bishop is the debt manager for World Telephone, which needs 3.33 billion Euro financing for its operations. Bishop is considering the choice between issuance of debt denominated in:

Euros (), or

U.S. dollars, accompanied by a combined interest rate and currency swap.

a. Explain one risk World would assume by entering into the combined interest rate and currency swap.

Bishop believes that issuing the U.S.-dollar debt and entering into the swap can lower Worlds cost of debt by 45 basis points. Immediately after selling the debt issue, World would swap the U.S. dollar payments for Euro payments throughout the maturity of the debt. She assumes a constant currency exchange rate throughout the tenor of the swap.

Exhibit 1 gives details for the two alternative debt issues. Exhibit 2 provides current information about spot currency exchange rates and the 3-year tenor Euro/U.S. Dollar currency and interest rate swap.

b. Show the notional principal and interest payment cash flows of the combined interest rate and currency swap. Note: Your response should show both the correct currency ($ or ) and amount for each cash flow.

Answer problem b in the template provided.

c. State whether or not World would reduce its borrowing cost by issuing the debt denominated in U.S. dollars, accompanied by the combined interest rate and currency swap. Justify your response with one reason.

Exhibit 1

World Telephone Debt Details

Chracteristics Euro Currency Debt US Dollar Currency Debt

par value EUR 3.33billion $3billion

term to maturity 3 years 3 years

fixed interest rate 6.25% 7.75%

interest payment annual annual

Exhibit 2

Currency Exchange rate and swap information

Spot currency exchange rate $0.90 per Euro ($0.90/EUR 1.00)

3-year tenor Euro/US Dollar fixed interest rates 5.80% Euro /7.30% US Dollar