Question
Devil VCR Corporation is a U.S.-based company that produces videocassette recorders. Three years ago, Devil established a production facility in the United Kingdom, since it
Devil VCR Corporation is a U.S.-based company that produces videocassette recorders. Three years ago, Devil established a production facility in the United Kingdom, since it sells VCRs there. Devil has excess capacity there, and will use that facility to produce the VCRs that are to be marketed in Singapore. The VCRs will be sold to distributors in Singapore and invoiced in Singapore dollars (S$). If the exporting program is very successful, Devil Corporation will probably build a facility in Singapore, but it plans to wait at least ten years. Prior to this exporting program, Devil Corporation decided to develop a hedging strategy to hedge any cash flows to the U.S. parent. Its plan is to issue bonds to finance the entire investment in the exporting program. Virtually all expenses associated with this program are denominated in pounds. Yet, the revenue generated by the program is denominated in Singapore dollars. Any revenue above and beyond expenses is to be remitted to the United States on an annual basis. Aside from the exporting program, the British subsidiary will generate just enough in cash flows to cover expenses and therefore will not be remitting any earnings to the parent. Devil Corporation is considering three different ways to finance the program for ten years. Issue ten-year, Singapore dollar-denominated bonds at par value; coupon rate = 11%. Issue ten-year, pound-denominated bonds at par value; coupon rate = 14%. Issue ten-year, U.S.-dollar-denominated bonds at par value; coupon rate = 11%. Discussion Question: Describe the exchange rate risks for each of the above and give the relative advantages and disadvantages.
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