4 10 pts Sambuka Inc can issue annual coupon bonds in either

4) (10 pts) Sambuka, Inc. can issue annual coupon bonds in either U.S. dollars or in Euros that mature in three years. Dollar-denominated bonds would have a coupon rate of 5 percent; Euro-denominated bonds would have a coupon rate of 4 percent. Assuming that Sambuka can issue bonds worth $10,000,000 in US dollars or 8 million Euros, given that the current exchange rate is $1.25/1 Euro. a) If the forecasted exchange rate for the Euro is $1.28/1 Euro for each of the next three years what is the annual cost of financing for the Euro-denominated bonds? Which type of bond should Sambuka issue?

Solution

Year 1 Year 2 Year3 Payment in Euros 320000 320000 320000 Exchange rate $/Euro 1.28 1.28 1.28 Payment in $ 409600 409600 409600 Cost of financing for Euro bonds = 409600/10000000 = 4.10% As the cost of the dollar denominated bond is higher at 5%, Sambuka should issue Euro denominated bonds.