Problem 7 You are a corporate treasurer for Esso Oil. The quoted rate on dollar
ID: 2736473 • Letter: P
Question
Problem 7 You are a corporate treasurer for Esso Oil. The quoted rate on dollar denominated euro commercial paper has just blipped down recently. Your firm can issue $ 10 million of 180-day euro commercial paper in the London markets at 3.45%. (Commercial paper in the London markets is sold at a discount). You can invest the proceeds in the United States in comparable maturity negotiable dollar-denominated CDs, which are quoting 3.95%, Ignoring any transactions costs, how much money, if any, can Esso make by borrowing in the euro markets an investing in the United States? Is this a good deal or not? Should you expect it to last? Explain.
Explanation / Answer
Total Value of commercial paper issue = $10 million
Discount rate of bond issue = 3.45%.
Issue price of Commercial paper = $100 / (1 + 3.45%)
= $96.665
Totals Proceed from sale of Commercial paper = $10 million × ($96.665 / $100)
= $9,666,505.56.
Total Proceeds from sale of commercial paper is $9,666,505.56.
Now He invest the proceeds from commercial paper in USA which gives a return of 3.95%.
So total value of investment after 6 month = $9,666,505.56 × (1 + 3.95%)
= $10,048,332.53
So total value of investment after 6 month is $10,048,332.53.
At maturity of commercial paper after 6 month the company has to pay $10 million to investor because commercial paper was issued at discount.
So total Gain from investment = $10,048,332.53 - $10,000,000
= $48,332.53.
Since company earn profit by issuing commercial paper and investing proceed in USA of $48,332.53. So it is a good deal.