Case Scenario $($C$)$

Maggie Cho is the founder and CEO of an international designer brand specializing in luxury goods. Although her company is based in Canada, most of the operations are in Australia. She has recently approved a business proposal to expand her company's operations in the Australian market. According to her CFO, the company would need to borrow CAD $100$ million for $5$ years to finance the expansion.

Maggie decides to engage an American investment bank, Silverman Zax, to discuss financing options. The Silvei$$man bankers suggest three options:

Option I $"$A $5-$year foreign bond denominated in AUD. The interest rate is $5\mathrm{.}00\%,$ payable annually."

Option $2"$A $5-$year Eurobond denominated in CAD. The interest rate is $3\mathrm{.}00\%,$ payable annually."

Option $3$

$"$A $5-$year Eurocredit term loan denominated in AUD. The interest rate is LIBOR plus I $\mathrm{.}00\%,$ payable evety $6$ months. Principal to be repaid at maturity."

Maggie raises two concerns. First, she is unsure what are the differences between a foreign bond and a Eurobond. Second, her company operates a centralized debt denomination model and wonders how exchange rate movements between the CAD and AUD would affect the ability to repay the debt. In response to her second concern, the Silverman bankers add that they can offer a forward contract to mitigate exchange rate currency risk.

At this point, Maggie's CFO interjects that the company has a AA credit rating and should have a credit spread of $75$ basis points $($bps$).$ The Silverman bankers clarify that the $75$ bps spread would apply only if the Eurocredit loan is denominated in CAD. The bankers also provide additional information shown in Exhibit $4.$

Exhibit $4$

AUD$/$CAD spot rate

CAD $6-$month LIBOR

CAD I$-$year LIBOR

AUD $6-$month LIBOR

AUD $1-$ ear LIBOR $1\mathrm{.}10$

$2\mathrm{.}00\%$

$2\mathrm{.}50\%$

$4\mathrm{.}40\%$

$4\mathrm{.}75\%$

$($l l$)$ What is the regulatory implication of choosing Option I over Option $2?[4$ marks$]$

$(12)$ Explain the centralized debt denomination model. Also, explain whether a MNC with a centralized model would likely face more or less exchange rate risk affecting debt repayment compared to a MNC with a decentralized model? $[4$ marks$]$

$(13)$ If Maggie selects Option l $,$ Silverman Zax could offer a forward contract with a $5-$yeat' maturity to mitigate the AUD$/$CAD exchange rate risk. Calculate the AUD$/$CAD forward rate for the contract if Maggie's company has a AAA $($i$.$e$.,$ default$-$free$)$ credit rating. $[4$ marks$]$

$(14)$ Referring to Option $3,$ how much interest would Maggie's company need to pay in $6$

months? What would be the interest payment in $6$ months if the Eurocredit is denominated in CAD? $[4$ marks$]$

$(15)$ Maggie's CFO asks the Silverman bankers whether the company could repay principal in AUD and pay interest in CAD. Propose a bond instrument that meets this requirement and explain why it could be suitable for the company. Include in your answer, the currency in which the bond is issued. $[4$ marks$]$