Walt Disney

The Walt Disney Company’s Yen Financing

Motivations for Currency Swaps 1. Currency risk management Match the currency exposure on the asset side with similar currency exposure on the liability side, or convert foreign currency earnings to domestic currency. 2. Arbitrage Profits based on comparative cost advantage Cost European Apples American Apples Beliz

1 ECU

0.75 dollars

Dan 1.25 ECU 1.5 dollars ------------------------------------------------------------------Beliz’s advantage 0.25 ECU 0.75 dollars 0.1875 dollars 0.25 ECU Assuming 1ECU = 0.75 dollars

vs. 0.75 dollars vs. 1.00 ECU

Comparative advantage = 0.75 – 0.1875 = 0.5625 dollars, or, = 1.00 – 0.25 = 0.75 ECU Beliz likes European apples and Dan likes American apples. Both like to eat three apples a day. Without trading Beliz must spend 3ECU or 2.25 dollars Without trading Dan must spend 4.5 dollars or 6 ECU Beliz and Dan do an American/European Apple Swap Beliz buys three American apples and Dan buys three European apples. They swap their fruits. Beliz spends 3 X 0.75 dollars = 2.25 dollars or 3 ECU Dan spends 3 X 1.25 ECU = 3.75 ECU or 2.8125 dollars Dan pays 1 dollar (or 1.333 ECU) to Beliz Beliz’s cost = 2.25 - 1.00 = 1.25 dollars or 1.666 ECU Dan’s cost= 3.75 + 1.333 = 5.0833 ECU or 3.8125 dollars Beliz saves 1 dollar (or 1.333 ECU) and Dan saves 0.6875 dollars (or 0.9166 ECU). Together they save 1.6875 dollars (or 2.25 ECU) which is equal to the comparative advantage per fruit of 0.5625 dollars (or 0.75 ECU) times 3 fruits.

Hedging Alternatives 1. Should Walt Disney Hedge (see Exhibit 4) 2. FX Forward Contracts Available at low cost only until 2 year maturity (see Exhibit 5) due to the high bid-ask spread Even if a quote is available, the dealers are unwilling to transact in any substantial size 3. Currency Futures and Options Similar problems as those of FX forward contracts 4. Balance Sheet Hedge (without a swap) Issue a yen term loan, or a yen bond. However, the Japanese market may not be ready. Walt Disney is a single-A rated company. The process is cumbersome requiring an underwriter, a “commissioned company,” and coordination with the “Bond Floatation Committee.”

French Utility’s Comparative Cost Advantage

Walt Disney (A)

ECU 9.256%

Yen 7.61%

French Utility (AAA) 9.16% 6.717% -------------------------------------------------------------French Utility’s 0.096% 0.893% advantage Comparative advantage = 0.893% - 0.096% = 0.797%

Details 1. Walt Disney – ECU loan (Exhibit 6) How does one get 78.499? 80 Million X 100.25% = 80.2 Million ECU - (80 Million X 2%) -$75,000 = 78.6 Million ECU - $75,000 = 78.6 Million ECU - 101,078.167 ECU = 78.499 Million ECU

78.499 = 7.3/(1 + x) + 7.3/(1 +x)2 +…..+ 17.46/(1+x)10 x = 9.47% Under semi-annual compounding, the YTM should equal 9.256%. 2. Walt Disney – yen loan Yen loan has a front end fee of 0.75%, and has interest of 3.75% paid every six months (see the last two paragraphs of page 4). Hence, 100 - 0.75 =3.75/(1+x) + 3.75/(1+x)2 +...+ 103.75/(1+x)20 x = 3.804% Since we are already using semi-annual compounding, the YTM equals 2 X 3.804% = 7.61% 3. French Utility - ECU loan See ECU- Mar 95 maturity loan in Exhibit 8. The YTM with annual compounding is 9.37%. Hence, the YTM with semi-annual compounding should be 9.16%. 4. French Utility – yen loan See yen - Jan 95 maturity loan in Exhibit 8. The YTM with annual compounding is 6.83%. Hence, the YTM with semi-annual compounding should be 6.717%

Walt Disney’s Cost of Yen Financing (Before and After the Swap) French utility needs ECU Debt in exchange for its yen debt. Walt Disney needs yen financing Which market should Walt Disney borrow in? Before the swap: Walt Disney’s cost of yen financing = 7.61% After the Swap Using column B in exhibit 7: 14,455.153 = 483.226/(1+x) + 483.226/(1+x)2 +… ...+ 1520.45/(1+x)20 x = 3.445% Since we are using semi-annual compounding, the Walt Disney’s cost of financing after the swap equals 2 X 3.445% = 6.89% Savings for Walt Disney = 7.61% – 6.89% = 0.72%

French Utility’s Cost of ECU Financing (Before and After the Swap) Before the swap: Even though the French Utility is not issuing new ECU debt, the existing interest rate on its ECU debt can be used as a benchmark for comparison French Utility’s cost of ECU financing = 9.16% After the Swap The Principal payments of 80 Million ECU and 14,445.153 Million yen in the first row of columns C and D in exhibit 7 are “notional” figures. These principal payments are not exchanged. They are only shown there because Goldman and IBJ used them for calculations (see footnote b in Exhibit 7). The French Utility receives (see column D, Exhibit 7): 483.226 Million yen in six months, 483.226 Million yen in 1 year, . . . 1520.45 Million yen in 10 years

These yen payments are worth their present value to the French Utility, or 14,592 Million yen 14,592 =

483.226/(1 + 0.06717/2)1 + 483.226/(1 + 0.06717/2)2 . . . + 1520.45/(1 + 0.06717/2)20

14,592 Million yen equals 79.296 Million ECU (at the current spot rate of 0.005434 ECU/yen). Hence, the French utility has received 79.296 Million ECU worth in yen cash inflows. By equating 79.296 Million ECU to the present value of its ECU cash outflows (see column C, exhibit 7), its ECU cost of financing can be computed: 79.296 = 7.35/(1+x) + 7.35/(1+x)2 +…+ 17.47/(1+x)10 x = 9.35% Under semi-annual compounding, the French Utility’s cost of financing should be 9.14% Savings for French Utility = 9.16% - 9.14% = 0.02%

IBJ’s Compensation IBJ receives 0.05 Million ECU for the first six years, 0.04 Million ECU in the seventh year, 0.03 Million ECU in the eighth year, 0.02 Million ECU in the ninth year, and 0.01 Million ECU in the tenth year (see the difference between columns A and C in Exhibit 7). This is roughly equal to less than 6 basis points on the size of the currency swap. Comparative advantage

= 0.797% = 0.80% approximately = 0.72% (savings to Walt Disney) +0.02% (savings to French Utility) +0.06% (compensation to IBJ) ---------------------------------------------= 0.80% (approximately)

How come Walt Disney got the biggest share and French Utility got virtually nothing?