1) What is a cross-currency swap?
2) How do currency swaps and cross-currency swaps differ?
3) Why would a company use a cross-currency swap?
4) Diagram and/or explain the cash flows that will take place over the life of the swap. Base your answer on the following broad stages in the life cycle of the swap:
a) start
b) during
c) maturity
5) The very name “cross-currency swap” would imply that BigWheels should be exposed to risk arising from changes in currency exchange rates. Does BigWheels have actual exposure to such risk? Why or Why not?
6) Do cross-currency swaps receive hedge accounting under FAS 133? Why or Why not?
7) What are the implications for BigWheels’ earnings based on your answer in question 6?
8)
Since both the interest and principal payments of a cross-currency swap
are not netted, BigWheels would most
likely make the US $ denominated interest payments out of its US $ cash
balance. For the sake of the
following exercise, assume that BigWheels instead chooses to convert francs to
dollars in order to meet its Exchange Contract Interest Payable
obligations. Also assume that the
value of the derivative is denominated in francs. Based on your understanding of FAS 133,
and its implications on cross-currency swaps, record the journal entries for
September 30, 1999 through September 30, 2001. Do not worry about closing the books at
the end of the accounting period.
Instead, allow your balances to accrue through out the two-year period to
see the effects of these transactions in the aggregate.
Bonus question: Why would BigWheels be more apt to meet its interest payment obligations from its US $’s on hand (as opposed to exchanging francs as we did in the previous example)? Hint: By exchanging francs to US $’s, what will appear on BigWheels’ books that really shouldn’t be there?
9) Assume that BigWheels makes all US $ denominated disbursements out of its US $ Cash account balance. Suggest (and illustrate) a way that BigWheels could account for its cross-currency swap. Do not forget the requirements FAS 133 has imposed on the firm. Are there any problems with this proposed method of accounting?
10) Assuming that you are no longer bound by FAS 133 requirements, suggest (and illustrate) your own method of accounting for BigWheels’ transactions. What are the advantages/disadvantages of using this method of accounting?
11) Look at the proposed amendment to FAS 133. What are its implications for cross-currency swaps?
12) Explain any strengths/weaknesses of the different methods of accounting for cross-currency swaps that you have not already discussed. Ie. FAS 133 accounting, verses the proposed changes, verses your own method. In your opinion, which of these is best? Consider the standpoint of both the company and possible investors in the company.
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