Question

Assume that Seminole, Inc., considers issuing a Singapore dollar?denominated bond at Its present coupon rate of 7.1 percent, even though it has no incoming cash flows to cover the bond payments. It is attracted to the low financing rate, since U. S. dollar-denominated bonds issued in the United States would have a coupon rate of 12 percent. Assume that either type of bond would have a four­?year maturity and could be issued at par value. Seminole needs to borrow $10 million. Therefore, it will either issue U. S. dollar denominated bonds with a par value of $10 million or bonds denominated in Singapore dollars with a par value of S$20 million. The spot rate of the Singapore dollar is $.50. Seminole has forecasted the Singapore dollar’s value at the end of each of the next four years, when coupon payments are to be paid:

                        End of Year                 Exchange Rate of Singapore Dollar

                                 1                                       $.52

                                 2                                        .56

                                 3                                        .58

                                 4                                        .53

Determine the expected annual cost of financing with Singapore dollars. Should Seminole, Inc., issue bonds denominated in U.S. dollars or Singapore dollars? Explain.

Answer 1

Singapore Bond:

Par Value = S $ 20 million, Market Value of Bond = Issued at par value and hence S $ 20 million.

Coupon Rate = 7.1 % per annum and Yield to Maturity = Coupon Rate (as bond is issued at par) = S $ 20 million

Annual Bond Cash Flows:

End of Year 1 = 0.071 x 20 = S $ 1.42 million = 1.42 x 0.52 = $ 0.7384 million

End of Year 2 = 0.071 x 20 = S $ 1.42 million = 1.42 x 0.56 = $ 0.7952 million

End of Year 3 = 0.071 x 20 = S $ 1.42 million = 1.42 x 0.58 = $ 0.8236 million

End of Year 4 = 0.071 x 20 + 20 = S $ 21.42 million = 21.42 x 0.53 = $ 11.3526 million

Cost of Financing in Singapore Dollars would be equal to the total PV of the S $ denominated bond's annual cash flows.

PV of S $ denominated Bond's Annual Cash Flows = 0.7384 / 1.071 + 0.7952 / (1.071)^(2) + 0.8236 / (1.071)^(3) + 11.3526 / (1.071)^(4) = $ 18.3334 million

Cost of Financing in USD = Par Value of Financing Raised = $ 10 million

As is observable the cost of financing in case of USD is lesser as compared to that of S $. Hence, bonds should be issued in US $.