Harley$-$Davidson is considering whether to issue bonds denominated in euros. The case suggests that this might allow the company to take advantage of the low real rates of return in European debt markets, but there are two complications:

First, issuing debt in a currency other than the US dollar might expose Harley$-$Davidson to exchange$-$rate risk.

Second, there are firm$-$specific and industry$-$specific factors that might also affect borrowing rates. The case provides estimates for the yields Harley$-$Davidson could expect for both euro$-$denominated and dollar$-$denominated issues, along with market and peer company data. The questions below are designed to evaluate the desirability of the euro$-$denominated issue.

$.$ The provided spreadsheet provides you with two currency rate forecasts,

one based on inflation rates $($expected exchange rates$)$ and one based on

interest rates $($estimates of forward rates$).$ Please familiarize yourself with

the basic calculations. These are based on the following relations. Given the

inflation rates for the euro $($EUR$)$ and US dollar $($USD$)$ that are provided

in the case, future spot rates are estimated from the following formula,

where t is the number of years into the future the rate is being forecasted,

S is the spot rate $($subscripted by time$),$ and $\backslash$pi indicates inflation rates

$($subscripted by currency $$ note that inflation rates do not change over

time$)$:

Given the interest rates for the euro $($EUR$)$ and US dollar $($USD$)$ that are

provided in the case, forward rates that could be used to hedge cash flows

for the next five years are calculated with the following formula, where t is

the number of years into the future the forward rate is being calculated, F

is the forward rate $($subscripted by time$),$ S$0$ is the spot rate at the time of

the case, i indicates interest rates $($subscripted by currency and time to

maturity since interest rates vary based on time to maturity$)$: