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Mcdonald'S Corporation'S British Pound Exposure: 1 Case

McDonald's uses a cross-currency swap to hedge its three main British pound exposures: 1) equity capital invested in its British subsidiary, 2) a loan provided to the subsidiary, and 3) royalty payments from the subsidiary to the parent company. The swap involves McDonald's paying pounds and receiving dollars to hedge against fluctuations in the pound's value that could affect the parent company. The company's manager, Anka Gopi, is concerned that new accounting rules will require McDonald's to recognize the present value of the swap's principal in other comprehensive income, increasing the risk to this financial measure.

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Joel Christian Mascariña
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835 views4 pages

Mcdonald'S Corporation'S British Pound Exposure: 1 Case

McDonald's uses a cross-currency swap to hedge its three main British pound exposures: 1) equity capital invested in its British subsidiary, 2) a loan provided to the subsidiary, and 3) royalty payments from the subsidiary to the parent company. The swap involves McDonald's paying pounds and receiving dollars to hedge against fluctuations in the pound's value that could affect the parent company. The company's manager, Anka Gopi, is concerned that new accounting rules will require McDonald's to recognize the present value of the swap's principal in other comprehensive income, increasing the risk to this financial measure.

Uploaded by

Joel Christian Mascariña
Copyright
© © All Rights Reserved
We take content rights seriously. If you suspect this is your content, claim it here.
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Download as PDF, TXT or read online on Scribd
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McDonald’s Corporation’s British Pound

Exposure

BUSN9241 International Business Finance and Banking

1 Case
McDonald’s Corporation has investments in over 100 countries. The company
considers its equity investment in foreign affiliates capital which is at risk, subject
to hedging depending on the individual country, currency, and market.
McDonald’s parent company has three different pound-denominated exposures
arising from its ownership and operation of its British subsidiary. First, the British
subsidiary has equity capital which is a pound-denominated asset of the parent
company. Secondly, in addition to the equity capital invested in the British af-
filiate, the parent company provides intra-company debt in the form of a 4-year
125 million ponds loan. The loan is denominated in British pounds and carries
a fixed 5.30% per annum interest payment. Third, the British subsidiary pays
a fixed percentage of gross sales in royalties to the parent company. This too is
pound-denominated. The three different exposures sum to a significant exposure
problem for McDonald’s.
The company has been hedging the pound exposure by entering into a cross-
currency U.S. dollar/British pound sterling swap.
Cross-Currency Swap: Pay Pounds-Receive Dollars
The current swap is a 7-year swap to receive dollars and pay pounds. Like all
cross-currency swaps, the agreement requires McDonald’s-U.S. to make regular
pound denominated interest payments and a bullet principal repayment (notional
principal) at the end of the swap agreement. McDonald’s considers the large
notional principal payment a hedge against the equity investment in its British
affiliate.
Anka Gopi is both the Manager for Financial Markets and Treasury

1
She wishes to consider the impact of FAS 133 on the hedging strategy currently
employed. Under FAS 133, the firm will have to mark-to-market the entire cross-
currency swap position, including principal, and carry this to other comprehensive
income (OCI). OCI, however, is actually a form of income required under U.S.
GAAP and reported in the footnotes to the financial statements, but not the
income measure used in reported earnings per share. Although McDonald’s has
been carrying the interest payments on the swap to income, it has not previously
had to carry the present value of the swap principal to OCI. In Anka Gopi’s eyes,
this poses a substantial material risk to OCI.

2 Case Questions
• How does the cross currency swap effectively hedge the three primary expo-
sures McDonalds has relative to its British subsidiary?
• How does the cross-currency swap hedge the long-term equity exposure in
the foreign subsidiary?
• Should Anka and McDonalds worry about OCI?

3 Learning Outcomes
• Explain how foreign currency futures are quoted, valued, and used for spec-
ulation purposes;
• Illustrate how foreign currency futures differ from forward contracts;
• Analyse how foreign currency options are quoted, valued, and used for spec-
ulation purposes;
• Explain how foreign currency options are valued;
• Define interest rate risk, and examine how can it be managed.

4 Preparation
The videos, slides and readings will give you the basic framework only of the
ideas, theories and concepts you will need to complete the assignment. These
notes will therefore not be sufficient on their own. You will need to make use of

2
the required reading, extra references and supplementary material you are provided
in the course of preparing your assignment. When you are taking notes for your
assignment, try and ‘translate’ what the author is saying into your own words.
Don’t just copy out huge chunks from other people’s work, otherwise they will
probably end up in your assignment with very little of the wording changed (which
is plagiarism).

5 Writing
Make sure you have understood what the assignment is getting at and that you
know how to complete it. In particular, please be aware that no assignment will ask
you just to write down everything you know about a subject area; instead, it will
require you to consider specific issues. Try to stick to the introduction, discussion,
conclusion format in your essay, that is, set the context of the essay and outline
the structure of your argument, cover the relevant material, then tie the discussion
up by summarising what has been said and offering YOUR opinion on what the
question is asking about, based on the sources you have used. You should provide
evidence for all the assertions that you make during your assignment; that is, make
reference to ideas, theories and concepts, empirical research and/or experience of
your own which support your claims. Remember to cite the sources of ALL the
ideas and quotations that you have used in-text. Also, don’t forget to provide a full
bibliography and don’t try and pad it out. Only list sources you have actually looked
at. Refer to the referencing guidelines provided for this topic. Develop your points to
make it clear what you are getting at and don’t leave arguments ‘hanging in mid-
air’.

Word Count: 1,500 to 2,000 Words

6 Referencing
All sources, whether academic books, journal articles, newspaper articles, mate-
rial from the internet etc., must be cited in the main text of your assignment
itself.

7 Marking Criteria
• Relevance of your answer to the question;

3
• Clarity of expression;
• Supporting documentation for arguments;
• Proper acknowledgement of documentation and the use of a bibliographic
convention;
• Overall presentation, including correct grammar, spelling and punctuation;
• Comprehensive coverage reflecting mastery of readings and text;
• Logical planning and sequence.
The assignment should contain at least three well defined and distinct sections:
• An introduction;
• A discussion (the body of the assignment);
• A conclusion.
You will need to pay attention to the following aspects of the case study:
• How to effectively use cross-currency interest rate swaps to manage medium-
to-long-term operational exposure.
• The critical factors in hedging the future value of a foreign investment;
• Insuring and hedging with currency options.
Please ensure that you are aware of the University’s Academic integrity pol-
icy.

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