The Walt Disney Company’s Yen Financing

The Walt Disney Company’s Yen Financing

The Walt Disney’s Yen Financing case is similar to R.J. Reynolds international financing case. The Walt Disney is a U.S.-based company that opened Walt Disney Japan in 1983. The Walt Disney made an arrangement with a Japanese firm to run Walt Disney Japan in return for receiving royalty payments in yens from the Japanese firm. These yen royalty receipts for Walt Disney (the parent company) were ¥8 billion in 1984, and were expected to grow by 10% to 20% per year over the next few years.

        Since the home currency of Walt Disney was U.S. dollars and its royalty receipts from Disney Japan were in yens, Walt Disney was exposed to the foreign currency exchange rate risk between dollar and yen. The Walt Disney was looking at possible options to manage this currency exchange rate risk. One issue you can look into is whether or not Walt Disney hedge its currency risk at this stage in 1985 when yen appears to have depreciated overtime against dollar and there are expectations of possible appreciation of yen against dollar in the future. Regardless of your decision to hedge or not on behalf of Walt Disney, you still need to go with all the hedging alternatives available to Walt Disney to hedge its yen royalty receipts from Disney Japan. Obviously, Walt Disney would like to match the currency of its revenue receipts with the currency of its debt liabilities to minimize exposure to currency exchange rate risk.

        The case outlines several options for Walt Disney to hedge the currency exchange rate risk of its expected yen royalty receipts using FX forwards, futures, options, and swaps. The main issue on hand for Walt Disney seems to be how much of its expected future yen receipts it should hedge, for what duration, and using what option? The available options to Walt Disney may be listed as follows:

1. The Walt Disney can convert its existing dollar debt (or issue new Eurodollar notes) to yen using the foreign-currency swap, as it has done earlier this year. However, this option does not provide any additional cash to Walt Disney, nor it lowers the company’s high debt ratio in U.S. dollars. In addition, any such swap deal would be short term given the short-term (1-4 years) maturity of Disney’s Eurodollar notes and Disney was likely interested in a longer-term deal.

1. Euroyen bonds in which principal and interest rates were paid in yens were another option, but Disney was not eligible to use such yen bonds as per regulations of Japanese government.

1. The Walt Disney was eligible to issue a ¥15 billion 10-year bullet loan and borrow this money from a Japanese bank. This yen liability could be met with the yen royalty payments from Disney Japan and may fully resolve the issue of currency exchange rate risk. Alternatively, Disney may use the yen forward contracts to convert yen debt to dollar debt (see Exhibit 5).

1. Goldman Sachs proposed an innovative option to Walt Disney to resolve its yen hedging problem. Goldman suggested that Disney issue 10-year ECU Eurobonds that would be swapped into a yen liability at a potentially lower all-in-cost interest rate than for a yen term loan (see Exhibits 6 &7). Goldman could arrange an ECU/yen swap intermediated by Industrial Bank of Japan (IBJ) which will match exactly Disney’s ECU payments with yen payments. The counterparty to the swap is a French utility firm that has an existing Euroyen bonds with a 10-year maturity. The French utility firm was eager to convert its yen debt into an ECU-denominated debt (ECU is now Euro). It turns out that the French firm has debt rating of AAA compared to debt rating of A for Walt Disney. This implies that the French firm may have an absolute advantage over Disney in borrowing money in yen or ECU (see Exhibits 8). But which market, ECU or yen, provides the French firm a comparative advantage (i.e., greater absolute advantage) to borrow money? This advantage may be used to possibly benefit all parties involved in the yen to ECU swap.  You may want to see the B.F. Goodrich-Rabobank swap example in Chapter 22 (Table 22.2, PP. 746-751) of Kolb book to better grasp the mechanics of Goldman’s ECU-yen swap proposal and the all-in-cost calculations. The all-in-cost interest rate calculations here could be done similar to all-in-cost Euroyen-swap calculations I showed for the RJR International Financing case (see iLearn handout). Another way to look at the possible sources of benefits (pie to be shared) to all parties would be to calculate the total annual interest paid in U.S. dollars by both Disney and French firm on their respective debts (using ¥/$ and ECU/$ spot rates) with and without the swap arrangement. If the combined annual interest paid by both firms is lower with the swap than without the swap, the difference is the total potential benefit that may be shared among the parties involved.  You may also want to discuss why opportunities of mutually advantageous swaps exist in this case.

You have to show and recommend which hedging option will be best for Walt Disney on the basis of all-in-cost and other related considerations.