Hould Disney Hedge Its Yen Royalty Cash Flow?
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1. Should Disney hedge its yen royalty cash flow? Why or why not? Is so, how much should be hedged and over what time frame?
I believe Disney should hedge its yen royalty cash flow due to the following reasons:
During fiscal 1984, yen royalty receipts were over 8billion, and these receipts were expected to grow at 10% to 20% per year over the next few years. If using 1984 average exchange rate 237.3, the yen royalty receipts in 1984 accounted for 3.07% of the total revenues of entertainment and recreation. Although 3% was not that much, given the expectation that the royalty receipts would grow over the next few years, yen royalty receipt would be an important part of revenues in the future.
At the end of year, converting Yen to dollar using average exchange rate or exchange rate at the end of the year was exposed to foreign exchange risk. Especially Yen was depreciating to dollar, the company would incur foreign exchange loss and it would affect the overall performance of the financial reports.
There are two kinds of participator in the derivative market, hedgers and speculators. Disney, in this case, shouldnt be a speculator who benefit from the increasing or decreasing exchange rate. Disney is an operating company and it should try to avoid any potential risk.
From exhibit 3, we can see the company had a yen term loan due on 2/1/93, with outstanding principal of Yen12.5 billion and semiannual principal payments of 765million (annual 1.53billion). The receipt of yen royalty in 1984 was 8 billion; Disney should hedge the difference between 8 billion and 1.53 billion, which was, 6.47 billion. The following years hedging strategy should be the same as 1984-hedging the difference between its yen royalty receipt and liability of yen. Since the loan due in 1993, which is 8 years from 1985, the company should hedge over long period.