Question (1)
Question (1A)
Dollar Regains Appeal in Carry Trades
Cost of using dollars to buy higher-yielding currencies is expected to remain low after the Fed pinned interest rates near zero
This year’s decline in the U.S. dollar is drawing investors back into a practice that they had eschewed for some years: Borrowing the greenback to buy riskier assets in what is known as a carry trade.
A number of investors are pursuing higher returns by buying overseas assets. Investment firm Ashmore Group, for instance, sold the dollar to add local-currency government bonds from Mexico, Indonesia and Brazil to its portfolios, according to Jan Dehn, head of research.
The dollar is being used to fund such trades after a drop in U.S. interest rates this year made it less attractive for investors to hold dollar-denominated assets. With the Fed pledging to keep U.S. rates near zero for the foreseeable future, it may stay that way for a while.
(September 29, 2020, WSJ)
Discuss potential risks in the carry trades described in this WSJ article. In your discussion, you can include points about challenges related to financial globalization.
Question (1B)
Emerging-Market Businesses Binge on U.S. Dollar Bonds
Foreign-currency bond sales from companies in developing markets climb to a record
Emerging-market companies sold a record amount of foreign-currency debt this year, taking advantage of low rates and investors’ appetite for better returns despite warnings about the growing risks of a global borrowing binge.
About $66.4 billion of bonds denominated in U.S. dollars, euros, and other currencies have been sold this year by nonfinancial businesses in countries such as China, Mexico, and Chile, according to Dealogic data. That is almost double the $34.2 billion raised in the first seven weeks of last year and the highest ever for the period, which is traditionally a busy time for issuance.
(Feb. 20, 2020, WSJ)
Discuss potential risks for emerging market firms that could arise from their reliance on foreign-currency-denominated debt.
[17 points]
Question (2)
Will Brexit Lead to Higher Funding Costs? Companies Aren’t Sure
More than $1.6 trillion in financial assets were shifted out of the U.K. since the 2016 referendum
Chief financial officers will have to wait and see if the U.K.’s exit from the European Union leads to higher funding costs and other charges, as many British and European companies loaded up on liquidity before the Dec. 31 deadline for a trade agreement, potentially masking any immediate effects of the split.
(Jan. 25, 2021, WSJ)
Discuss how international diversification can help firms enhance their financial flexibility when they face an exogenous shock.
[35 points]
Question (3)
Question (3A)
A U.S. company needs to raise €50,000,000. It plans to raise this money by issuing dollar denominated bonds and using a currency swap to convert the dollars to euros. The company expects interest rates in the United States to increase, while the euro zone’s interest rates to fall.
i. Should the swap be structured with interest paid at a fixed or a floating rate?
[5 points]
ii. Should the swap be structured with interest received at a fixed or a floating rate?
[5 points]
