This case is concerning about the strategies of funding for a semiconductor company's distribution center and technical support facility in U.K. They decided to fund with debt with dollars or pounds, but the company is facing the exchange risk due to the different locations of the parentcompany and subsidiary. The company in U.K. has to import goods from America and then sell them in U.K. so the appreciation of dollar and depreciation of pound may cause adverse effect on the company's profit.
According to the analysts' conclusion, there are two financing alternatives, take a five-year loan in U.S. dollars at 8% per annum or in pound sterling at 12% per annum with a rest of fund comes from equity. The difficulty of choice between these two choices is that the differences between interest rates and foreign exchange rates which lead to the cost and risk to the firm. With these different choices people are inclined to different opinions which I will explain and evaluate later. The spot rate of for STG was quoted at approximately USD 2.40, so the five-year forward rate is 2USD/GBP ( ). While the market forward rate is 1.97USD/GBP, it means that GBP was undervalued in the market.
The different opinions given by different parties can be concluded for the following three: taking a loan in pounds; borrowing in dollars; half pounds and half dollars loan. When the market undervalued the pound, the pound continues to go down, which means borrowing in more pounds and returning less pounds so the company does a good hedge. Under this circumstance, both the local management and the Director of Foreign Exchange were right.