Bond Selection
A “make-whole” call allows the issuer of a bond to pay off the bond early. The payment to the bondholder is based on the net present value of the future payments remaining on the bond (Investopedia, 2012). This provision does not necessarily make the investors whole. The investors receive the net present value of the future payments on the bond. For the investor, the discount rate used to calculate the net present value should be the same rate at which the investor can re-invest those funds with the same risk level. In many cases, however, the discount rate used for the NPV payment would either be written into the provision, or would be determined by the bond issuer. Thus, the discount rate could be a higher or lower than the reinvestment rate of the investor. So while there is no guarantee that this provision would fail to make the investor whole, there is the risk to the investor that he or she might not be made whole should the provision be called.
There should not be a difference between the zero coupon and regular coupon bond at the time of issue. They should both reflect the current risk situation with respect to prevailing interest rates, so that the yield to maturity is neural to the type of bond issued. Over time, however, changes in interest rates would have an impact on the value of the bond. Thus, whether a zero coupon bond or a normal coupon bond is better would depend on the issuer’s view of future interest rate changes. Unless there is a compelling financial reason to issue a zero coupon bond — and bear in mind that expectations of future rate changes are basically gambling — I would recommend a regular issue simply because there is a bigger market for regular bond issues than there is for zero coupon bond issues. I would also recommend offering a normal call feature rather than a make-whole call feature. The risk associated with the make-whole feature that could result in a small loss to the investor is something that could reduce the market for the bond. Again, in order to ensure that all of the bonds are sold, it is best to utilize the most common bond features, and that includes a regular call feature.
5. After the commission, the sales will be €4.75 million per month. Gross sales (€5 million) in dollars would be $6.85 million. Production costs would therefore be (.7)($6.85) = $4.79 million per month. The net sales would be $6.5 million, so the profit at this exchange rate would be $1.71 million. Because there is going to be a 90-day lag between the completion of the order and the payment, this is at least a 120 day lag, including production time, between the order and the payment. This subjects the company to a high degree of foreign exchange rate risk. The breakeven exchange rate between euros and dollars is 0.959. This represents a dramatic change from the current exchange rate. The euro has not been at this level in the past five years (Oanda, 2012).
Thus, there is basically no risk that the euro will change the rate so significantly in the next four months as to erode the company’s profit margin. Additionally, there is an active and liquid hedging market for the EUR/USD pairing, and this will allow East Coast to lock in today’s rate, for a small fee. As such, it is recommended that East Coast Yachts sell internationally. The volatility in the EUR/USD pairing is relatively low, certainly for any four-month span, and the margin that East Coast would take at today’s exchange rate is such that the company will earn profits even with a major change in the rate. As such, there is no financial reason to avoid the European market. This is especially the case given the ease of hedging the value of the European sales.
Works Cited:
Investopedia. (2012). Make whole call provision. Investopedia. Retrieved February 12, 2012 from http://www.investopedia.com/terms/m/make-wholecall.asp#axzz1m6xHDhx6
Oanda. (2012). Historical exchange rates. Oanda.com. Retrieved February 12, 2012 from http://www.oanda.com/currency/historical-rates/
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