Redhook Projection

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Question #2

Bank run: usually is used to describe a situation of panic. Specifically, it occurs when a large group of bank’s customers ask to withdraw their deposit at the same time. The reason why it happens is that the customers’ concern about the bank’s insolvency. When more and more people go the bank to withdraw their money, it will result in higher probability of default. Normally, there is the capital adequacy requirement for the banks, which is protecting the bank or other financeial institutions from insolvent. However, when bank run happens, in some cases, the bank’s reserves might not be adequate to cover the withdrawals. At that time, the panic would occur, and it might be turn into a true default.

In order to protect the firms, customers of the ban, the government and even the economy. Therefore, for the banks, it is important to hold enough capital to ensure continuation o a safe and efficient market so that they are able to deal with any problems might be ccur in the future with lower risk.

Question #4

The multinational manufacturing firm is planning to raise amount of capital of $200 million euros. In order to lower the cost of capital of the firm, it is important to analyze these two currencies through their borrowing cost so that we can make our choice of the bond issue from these two currencies.

For the bond issue company, the Internal Rate Return(IRR) provides a quick way of making comparisons of returns on bonds of various coupons and maturities. Also, foreign currency exposure on interest expenses of bonds can be generally hedged through currency-forward contracts. So we analyze the cost in euros of each bond alternative by using foreign- exchange rate set in today’s forward contract.

Specifically, first, I convert total amount of EUR200 million to the currency of CHF by using today’s spot rate(1.453%). CHF=$200million euro* 1.453%. second, we can get the interest expense for each year and the principals need to returned at the last year in CHF through the par value of bonds in CHF and its corresponding coupon rates. After that, we use the forward FX rates of each year to convert the expense of CHF to the euros because we can loack our prices today through the currency forward contracts. The forward FX rates can be calculated by using interest rate parity :

FT = S0 {(1+rdomestic)T}/(1+rforeign)T}

In the end, we compare IRR in euros of each bond alternatives. As we can see the result with the attached chart, 5.25% is the smallest IRR in euros, the firm can minimize the capital cost by borrowing euros. Therefore, my choice is to issue bond in euros.

[pic 1][pic 2]

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