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Assess the possibility for the euro to become another global currency rivaling the U.S. dollar. If the euro really becomes a global currency, what impact will it have on the U.S. dollar and the world economy?

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Casey Durgan
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5 Mar 2018

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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 World’s 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

1. What are the issues surrounding ones foreign exchange?

2. What impact on exports and imports?

3. What is impact of inflation on the foreign exchange in a country?

4. What is the impact when a country’s currency is affixed to the dollar?

5. Should there be a global currency such as the DEY (combination of the Dollar-Euro-Yen)?

As a finance officer at your company, you have been asked to conduct an analysis of the possible impact on your corporation of the new currency, the euro, which started circulating on January 1, 2002, in 12 of the 15 European Union member countries. International sales are important to the company and are expected to increase continuously in the future. The prospects for substantial growth from international sales will depend on the correct management of European markets and finances. (Although the euro started circulating on January 1, 2002, it was launched on January 1, 1999 and so euro-denominated bonds and equity already existed on January 1, 2002 and are increasing.)

1. In the long run, will the creation of the euro boost your company's international business volume?

2. Your company plans to issue euro-denominated bonds. Will it matter whether you hire a Dutch bank or an Italian bank? Why or why not?

3. Use the dollar and interest rate figures in your text to explain the need to distinguish between real and nominal interest rates when predicting exchange rate movements.

4. Assume that today is January 1, U.S. $1.00 = .90 euros, and the interest rate on dollar deposits is 3%. If in one year:

a. the dollar appreciates relative to the euro by 10%, what will be the return on dollar deposits in terms of euros?

b. the dollar depreciates relative to the euro by 20%, what will be the return on dollar deposits in terms of euros?

c. the expected exchange rate is U.S. $1.00 = .95 euros, what is the expected rate of depreciation for the dollar?

d. the dollar is expected to appreciate 5%, what interest rate on euro deposits is required if the concepts of interest-rate parity and capital mobility are to hold?

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