Question

ABC (US Firm) needs to raise USD1 billion or equivalent to acquire XYZ (US Firm). Therefore, ABC firm is trying to decide between the following three types of bond issues. Types of Bonds Coupon Rate (p.a.) No of Coupon Payments in a Year Initial Fees (at t=0) One-off Debt Maturity Exchange Rate (per USD) [Hint] Possible Internal Rate of Return (IRR) p.a. U.S. bond 6.75% 2 0.95% 3.554% 4.554% Euro- Eurobond 6.88% 1 0.55% 3 Euro 0.75 6.090% | 7.090% Samurai Bond 4% 1 0.30% 2 Yen 80 4.159% 5.159% Required: a) Assuming all else is equal, which is the least expensive bond issue solely based on All-in cost for ABC firm? Please show your full workings. [Hint: Compare the annualized yield to maturity (YTM) for each bond issue. Use the possible internal rate of return given above to speed up your calculation.] (7 marks) b) Please name the three unique characteristics of Eurobonds in not more than three sentences. (3 marks)

Answer 1

Answer :

a)

NPV of U S Bonds :

Period	Particulars	Amount	Factor @ 3.554%	PV
0	Bond Price	1000000000	1	1000000000
0	Cost to Issue Bonds	= - 1000000000 x 0.95% = - 9500000	1	- 9500000
1-6	Interest Half Yearly	= 1000000000 x 6.75% /2 = - 33750000	5.3191	- 179520107.92
6	Principal of Bond	= - 1000000000	0.8110	- 810958677.44
	NPV			- 21214.64

NPV of Euro Bonds :

Period	Particulars	Amount in US $	Conversion rate 1 Euro to USD	Euro	Factor @ 6.090%	PV
0	Amount of Bond	1000000000	0.75	750000000	1	750000000
0	Cost of Issue of Bond	= -1000000000 x 0.55% = -5500000	0.75	-4125000	1	-4125000
1-3	Interest on Bond	=-1000000000 x 6.88%	0.75	-51600000	2.6686	- 137699760
3	Payment of Bond	-1000000000	0.75	-750000000	0.8375	- 628125000
	NPV					-694949760

Amount of NPV IN $ - 926599680 ( -694949760 /0.75 )

NPV of Samurai Bonds :

Period	Particulars	Amount in US $	Conversion rate 1 YEN to USD	YEN	Factor @ 4.159%	PV
0	Amount of Bond	1000000000	80	80000000000	1	80000000000
0	Cost of Issue of Bond	= -1000000000 x 0.30% = -3000000	80	-240000000	1	-240000000
1-2	Interest on Bond	=-1000000000 x 4%	80	-3200000000	1.8818	- 6021780274.20
3	Payment of Bond	-1000000000	80	-80000000000	0.9217	- 73736000000
	NPV					2219725.80

Amount of NPV in US $ 27746.57 ( 2219725.80 / 80 )

Note we are using lowest of two rates of Possible Internal Rate of Return for calculation of PV of bonds

As NPV of Samurai Bond is Positive therefore ABC firm should issue Samurai Bond as it covers all costs

b) Unique Charactoristics of Euro Bonds :

1. It has fixed rate of interest as return

2. It is convertible bond and can be converted in stock, gold

3. Euro Bond is generally issued by other countries having different currency to invest in euros , therefore it is multi currency bonds or dual currency bonds