Walt Disney Yen Financing free essay sample

Should Disney hedge its yen royalty cash flow? Why or why not? If so, how much should be hedged and over what time period? Yes, Walt Disney Company should hedge its royalty cash flow to protect against currency fluctuations. The company has revenues in Yen and does not have expenses in Yen. Thus it would be converting the Yen to Dollar and so is exposed to foreign exchange risk. The value of Yen has declined recently and it is difficult to forecast what the value could be in the future. Also currency speculation should be left to speculators and Disney should not play on the exchange rate. It would be wise to educe the risk due to changes in exchange rate. The royalty receipts form a significant part of the pre tax income of Disney and any adverse movement would impact the financial position of Disney. The maximum amount and the period should be the Yen royalties that accrue to Disney. At the moment the amount is Yen 8 billion. The royalties are expected to grow for all times in the future and so the hedging should be for the maximum maturity available which is 10 years. At the minimum, Disney may Disney may want to take enough money so as to reduce the debt to capitalization ratio back to 20% which now stands at 32%. The expected yen revenue stream of more than billion every year would create 2. Assuming a hedge is desirable what hedging techniques available to the treasurer? What are the advantages and disadvantages of each? The various hedging techniques available and the advantages and disadvantages are : 1. Currency Options In this Disney could buy dollar yen options allowing Disney the right to buy dollars against yen at a predetermine rate or could sell Put options allowing Disney to sell yen for dollars at a predetermined rate. The advantages of options are It gives the right but not the obligation. If the Option is out of the money it need not be exercised. Options have an unlimited upside but limited downside so will help Disney benefit from favorable rate movement. Options can be taken for high amounts using small margin money The disadvantages are The time period for which options are available is till 2 years only. Beyond 2 years the market is not liquid Options require payment of upfront premium and so there will be a cash outflow 2. Forward Contracts In this Disney could take a forward contract through a bank and sell the Yen forward for US Dollars at a rate that is fixed now. The advantages are Forward contracts can be tailored to the needs and requirements of Disney Longer term contracts are available and Disney could hedge up to 10 years The forward contracts can be cancelled and so provide some flexibility in the future years The disadvantages are The rate is locked at the time of contract and so there is so upside benefit The forward contracts need to be honored at maturity and so Disney has to settle it As to Disney and so would tie up lines of credit Forward contracts are exposed to default risks of the counterparty 3. Futures Futures are standardized contracts hich are traded on the exchanges. That is the only difference between forward contracts and futures. Disney could buy or sell contracts on the futures exchange and hedge its exposure. The advantages are : They are liquid as they are traded on the exchange Using futures would not tie up the lines of credit with the banks There is not much default risk as the futures are market to market daily. The disadvantages are As these are standardized, they cannot be customized to the requirements Require a margin deposit The futures contracts are available for shorter periods only 4. Swaps Disney ould swap its exposure in Yen with Dollars so that its inflow is in Dollars and it pays Yen The advantages are Swaps are off balance sheet financing with only disclosure in notes. Thus the balance sheet looks better The two parties to Swap could customize the terms to their requirements Swap enables parties to access capital markets which they may not able to do directly The disadvantages are High fees to be paid to the intermediaries It is difficult to get counterparties with a perfect hedge 4. Yen 15 billion 10 year bullet loan The advantages are The time period would be 10 years Ђ The interest rate would be the Japanese prime rate Since it is a bullet loan it does not help in hedging the year on year income Requires lump sum payment on maturity It is more expensive than the SWAP transaction Has upfront fees Other hedging methods such as issuing longer maturity Eurodollar note was not feasible because of the Disneys temporarily high debt ratio. Also, Euroyen bonds are not an option because Disney was not eligible to issue them under Japanese regulations. 3. In light of the various other techniques for hedging currency exposures why the market for currency swap does exists? Who benefits and who looses in such an agreement? Can a swap really create value for a corporation? And if so where does the value come from? What risks does the swap carry for the various parties involved? The market for swap exists since it allows parties to access market which they might not be able to do directly. Also swaps are customizable between parties and so are more flexible. The duration of swaps could be the duration of the exposure. These advantages have led to the creation of the swap market. Swaps also help in and then use a swap to get back to their home currency. Swap also helps in lowering he overall cost of borrowing as also enable firms to change their payment stream to either fixed or floating. When the swap is initiated for the first time, it creates value since only if value is created will the parties agree for a swap. The value comes for the differing credit ratings of the firms. In interest rate swaps, two firms come together to swap their interest obligations and each mat find that it is paying a lower rate than before. The risks that the swaps carry is the changes in the market after the swap has taken place. ves