The Sundance is a U.S. MNC desiring to finance a capital expenditure of its German subsidiary. The project has an economic life of five years, and the cost of the project is 40,000,000. At the current exchange rate of $1.30/1.00, the parent firm could raise $52,000,000 in the U.S. capital market by issuing 5-year bonds at 8%. The parent would then convert the dollars to euros to pay the project cost. It is obvious that a transaction exposure would be created if the euro appreciates substantially against the dollar. An alternative is for the U.S. parent to raise 40,000,000 in the international bond market by issuing euro-denominated Eurobonds for a term of five years at a fixed rate of 7%. Allianz is a well-known German MNC of equivalent creditworthiness who has a mirror-image financing need of $52,000,000 to finance a capital expenditure with an economic life of five years. Allianz could raise 40,000,000 in the German bond market at a fixed rate of 6% and convert the funds to dollars to finance the expenditure. Alternatively, Allianz can borrow in the U.S. market at a fixed rate of 9 percent.

Can you arrange a currency swap that would solve the double problem of each MNC and benefit both the Sundance and Allianz? Explain. [4+4 marks]

Determine the annual interest payments between the Sundance and Allianz.

[4+4 marks]

What are the principal sums that each MNC has to remit at the commencement and the maturity of the currency swap? [2+2 marks]