Q: Determine the annual effective financing percentage cost of the yen-denominated notes issued in each of the three scenarios in the Blades case for the future value of the yen.
Scenario 1: No change in value of yen
Scenario 2: 2% appreciation in the value of yen relative to Baht
Scenario 3: 3% appreciation in the value of yen relative to Baht
Q: Determine the probability that the financing cost of issuing yen-denominated notes is higher than the cost of issuing baht-denominated notes
As we may note from the above spreadsheet table, under all the three scenarios, the annual financing costs of issuing yen denominated notes is 13.30%. Therefore, the probability that the company will issue yen-denominated notes at a rate higher than that of baht-denominated notes, i.e. at 15%, is zero(0).
Q: Explain whether the effective financing cost of the yen-denominated notes and the baht-denominated notes would be affected by exchange rate movements.
Referring to the case details, we believe that impact of exchange rate movements on the yen-denominated notes and the baht-denominated notes will be different. Important to note, if the company opt to issue notes denominated in baht, then it will not effected with the exchange rate movements as the company will only use the cash flows generated from subsidiary based in Thailand to meet interest and principal obligations related with baht-denominated notes. Therefore, since no other foreign currency will be into the picture here, the baht-denominated notes will not be affected by exchange rate movements.
However, if the company opt to issue yen-denominated notes, then it will be impacted by the exchange rate movements as in order to meet the interest and principal payments in Yen, the company will need to convert the cash flows generated in Baht to Yen, and in case of any fluctuation in the exchange rates, the company will be exposed to interest rate risk. For instance, if at the time of payment, Yen appreciates against Baht, then Blades Inc. will need to purchase more Baht and will result in additional cash outflow, and coupon rate higher than 10%. On the other hand, if at the time of payment, Yen depreciates relative to Baht, the company will need fewer Baht to meet the payment obligaton. In this situation, the coupon rate will be lower than 10%. Henceforth, if Blades Inc. issue Yen-denominate notes, then it will be exposed to interest rate risk.
Determine how the expected annual effective financing percentage cost of issuing yen-denominated notes compares with the expected financing cost of the baht-denominated notes.
We have used the average effective interest rate so obtained under scenario analysis to calculate the the expected annual effective financing percentage cost of issuing yen-denominated notes.
As noted from the above table, we can see that effective financing cost of Yen-denominated notes is 12.09%, which is less than the financing cost of issuing yen-denominated notes, i.e. 15%
Develop your recommendation on whether or not Blades, Inc. should go with yen or baht denominated notes. Support your recommendation with facts and point out any risks associated with your decision
On the basis of above analysis, it is clear that effective financing cost of Yen-denominated notes is less than the financing cost of issuing yen-denominated notes, and hence, Blades Inc. can go ahead and issue yen-denominated notes. Therefore, it is clear that under the given assumptions of 2% and 3% appreciation of Yen against Baht, our analysis stands valid.
However, the most important trade-off in this whole scenario is the possible appreciation of yen against baht on the higher side to what we have assumed. For instance, if Yen appreciates against Baht at around 10% or higher, in that case, the effective financing costs will be higher than that in baht. Moreover, considering the present situation in the currency market, where Yen is undermining even a globally strong currency such as US Dollar, the company should understand that by issuing Yen-denominated notes, it will be taking high risk if Yen follows the upside trend. However, during the recent years, Bank of Japan has been more focused on increasing the monetary stimulus in the economy, which is resulting in currency devaluation. Market analysts are expecting the Yen to trade around 115 against USD and also on the higher side against the other currencies as the nation’s central bank takes aggressive approach to enhance economic stimulus. Therefore, any depreciation of Yen against Baht will only benefit Blades Inc. by lowering its effective interest expense. However, the risk of exchange rate movements will always prevail and Blades Inc. cannot ignore the same risk involved in the issue of yen-denominated notes.
Secondly, since the Board of Directors has approved the subsidiary establishment in Thailand only, the company can avoid all such uncertainties related to exchange rate by issuing baht-denominated notes and pay all the interest and principal payments from the revenue earned in baht only.
Therefore, Blades Inc. should evaluate the trade-off of taking the exchange rate risk involved in the issue of yen-denominated notes versus stability involved in the issue of baht-denominated notes.
References
Adinolfi, J. (2016, February 17). Dollar weakens against euro, yen after Fed minutes. Retrieved April 14, 2016, from http://www.marketwatch.com/story/dollar-weakens-against-yen-rivals-as-investors-turn-skeptical-about-oil-deal-2016-02-17
Karunungan, Y. T. (2013, February 5). Yen Slide Against Baht a Boon for Thai Carmakers: Southeast Asia. Retrieved April 14, 2016, from Bloomberg: http://www.bloomberg.com/news/articles/2013-02-04/yen-slide-against-baht-a-boon-for-thai-carmakers-southeast-asia
Madura, J. (2015). Currency Derivatives. In J. Madura, International Financial Management (pp. 128-156). Cengage Learning.
Wong, A. (2014, October 31). Yen Declines to 7-Year Low on BOJ Monetary Easing. Retrieved April 14, 2016, from Bloomberg: http://www.bloomberg.com/news/articles/2014-10-30/yen-near-6-year-low-on-report-gpif-to-boost-foreign-securities
