McDonald's British
Pound Exposure
McDonald’s Corporation’s British
Pound Exposure
1. How does the cross currency swap effectively hedge the three primary exposures McDonalds has relative to its British subsidiary.
Currently, the British subsidiary of
McDonald's is assuming a fixed interest rate denominated in the pound. Through cross currency swapping the subsidiary of
McDonald's is able to break away from its fixed interest rate and can adopt the floating interest rate from its US parent company; they are participating in the swap of floating for fixed. In doing so they assume that with that there will be a drop in the floating interest rate reducing their fluctuating payments. This method also comes with a large risk.
The British subsidiary also takes on the added risk that the interest rate may increase with the float. Using this swap McDonald's will be paying out Pounds Sterling and slowly reducing their holdings of the foreign currency. With each payment they are reducing the risk associated with the Pound and their investment in a foreign country. The repatriation of royalties are being hedged to avoid future, more expensive payments. Swapping fixed for fixed. Possible solution is the pound pays off more of the principal balance? Above needs revamping.
2. How does the cross-currency swap hedge the long-term equity exposure in the foreign subsidiary?
McDonald's employs a swap hedging model that is seven years in length and allows it to receive dollars for payment of pounds. This is a cross- currency swap and requires
McDonald's to make regular payments in pounds and a final, or bullet, principal repayment when the swap agreement has ended.
Hedging occurs as McDonald's is trying to lock-in the cost of payment over a seven-year agreement and hedge against rising costs of paying for the pound and locking in