A Japanese auto company announces a new plant to be constructed in San Antonio, Texas. The company will partly finance the project with a dual currency bond offering. The $200 million offering will have a 6.0% coupon payable in yen and mature in 2021 with the final principal payment in U.S. dollars. Indicate whether a
U.S.-based investor and/or the company will assume any potential currency exchange risk related to these bonds.
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A. B. C.C
In this scenario, a Japanese auto company is planning to construct a new plant in San Antonio, Texas, and intends to partially finance the project through a dual currency bond offering. The bond offering is worth $200 million and has the following characteristics:
Coupon Payment: The bonds will pay a 6.0% coupon, which will be denominated in yen. This means that the company will make regular interest payments to bondholders in yen throughout the life of the bond until it matures in 2021.
Principal Payment: The final principal payment, which represents the repayment of the bond's face value, will be made in U.S. dollars. This implies that when the bond reaches its maturity date in 2021, the company will pay back the $200 million principal amount in U.S. dollars.
Based on these details, let's analyze the potential currency exchange risks associated with these bonds for both the U.S.-based investor and the company:
U.S.-Based Investor: The investor is exposed to currency exchange risk. Since the coupon payments are denominated in yen, the investor needs to convert the yen payments into U.S. dollars to realize their value. The exchange rate between yen and dollars can fluctuate over time, meaning the investor may receive varying amounts of U.S. dollars depending on the exchange rate at the time of conversion. These fluctuations in exchange rates can introduce currency risk for the investor.
Company (Issuer): The company also assumes currency exchange risk. The principal payment, which is the repayment of the bond's face value, will be made in U.S. dollars. However, the company generates its revenues in yen, as it is a Japanese auto company. Therefore, the company needs to convert yen into U.S. dollars at the maturity date to make the final principal payment. Fluctuations in the yen-to-dollar exchange rate can impact the amount of U.S. dollars required for repayment, potentially leading to currency exchange risk for the company.
Given these considerations, the correct answer is C. Both the issuer and the investor assume potential currency exchange risk related to these bonds. The investor faces the risk of fluctuating exchange rates when converting coupon payments from yen to U.S. dollars, while the company faces currency risk when converting yen revenues into U.S. dollars for the final principal payment.