CFA Examination Level II

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

• Euros (EUR), or
• U.S. dollars ( USD ), accompanied by a combined interest rate and currency swap.

a. Explain one risk World Telephone 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.

The following charts give the details for the two alternative debt issues and current information about spot currency exchange rates and the three-year tenor EUR/USD 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 (USD or EUR) and amount for each cash flow.

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.