Case study in Derivatives

The Walt Disney Company’s

Yen Financing

GROUP SIX
Liang Zhang
Xiao Cao
Xiang Wang
Le Lu

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Contents & Structure

Part I. Overview -----------------------------------------------------------------------------------------3

Part II. The problem facing Disney ----------------------------------------------------------------- 3

Status quo 1 - JPY royalties grows fast -------------------------------------------------- 3

Status quo 2 – JPY/USD rate fluctuation -------------------------------------------------3

Problem Summary --------------------------------------------------------------------------- 4

Part III. Various ways of hedging the exposure-------------------------------------------------- 5

Unsatisfied ways of Hedging ---------------------------------------------------------------5

Two Viable Alternatives --------------------------------------------------------------------- 5

(IRR analysis – compare the cost of each alternative)
Alternative 1 --- JPY Term Loan --------------------------------------------------5

Alternative 2 --- ECU Eurobond + ECU/YEN SWAP--------------------------- 6

ECU Eurobond ---------------------------------------------------------- 6

ECU/YEN SWAP -------------------------------------------------------- 7

Part IV. Conclusion ------------------------------------------------------------------------------------- 9

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 Harvard Business School

The Walt Disney Company’s Yen Financing

Part I. Overview
- the Walt Disney Company

The Walt Disney Company, a diversified international company headquartered in Burbank,

California, operated entertainment and recreational complexes, produced motion picture and
television features, developed community real estate projects, and sold consumer products. The
company was founded in 1938 as successor to the animated motion picture business established
by Walt and Roy Disney in 1923.
The company operated the Disneyland amusement theme park in Anaheim, California, and the
Walt Disney World destination resort in Orlando, Florida. In addition to the domestic
entertainment and recreation revenues from Disneyland and Walt Disney World, the company
received royalties, paid in yen, on certain revenues generated by Tokyo Disneyland. Owned and
operated by an unrelated Japanese corporation, Tokyo Disneyland was opened to the public on
April 15, 1983.
Consolidated revenues for The Walt Disney Company and its subsidiaries increased by almost 27%
in 1984 to $1.7 billion. Total entertainment and recreation revenues, including royalties from
Tokyo Disneyland, increased 6% to $1.1 billion in the fiscal year ended September 30,1984. Net
income totaled $97.8 million in 1984, an increase of 5% from 1983. Total assets grew 15% to $2.7
billion at the end of fiscal 1984.1

Part II. The problem facing Disney

- The possible exposure of Disney to future fluctuations in the yen/dollar spot rate

Status quo 1 - JPY royalties grows fast.

The JPY royalties from Tokyo Disneyland had increased significantly2 during the last year, and
Disney foresaw further growth (10%-20%) in the years ahead.

Status quo 2 – JPY/USD rate fluctuation

The current spot rate of 248 yen/dollar represented almost an 8% depreciation in the value of
the yen from 229.70 just over a year ago.

1
Excerpted from the “Walt Disney Company’s Yen Financing” case, the Walt Disney company.
2
The receipts has just over ￥8 billion
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But it has appreciated in the quarter since then. From the chart below, we can see that the U.S.
inflation has exceeded Japanese inflation for the past 5 years, which indicates the future
depreciation of dollar against Yen. Further more, the forward rate (Exhibit 5) also indicates the
same depreciation of dollar.

Figure 1:

Historical Summary of Average Yen/Dollar Exchange Rates and Price

Indexes
275
250
225
200
175
150
YEN/Dollar
125
U.S. CPI
100
Japan CPI
75
50
25
0
1980 1981 1982 1983 1984 1984 1984 1984 1985 1985
I II III IV I II

Source: compiled from Exhibit 4 of ‘The Walt Disney Company's Yen Financing’ case

Problem Summary
Disney needs USD for construction and expansion but not that much YEN cash flow. So, Disney
needs to transfer YEN to USD. Cause the JPY receipts are an huge amounts of money, a
depreciation of the JPY could deeply disrupt Disney’s financial plans. Given the fluctuation of
YEN/USD rate, this is a big exposure needs to be hedged. Considering the long term trend, maybe
it does not need to concern the depreciation of the JPY, but if the appreciation of JPY is lower
than expectation will also hurt Disney’s plan. Therefore, it can’t be more precise to arrange
comprehensively.

Our goal: hedging the exposure of Disney to future fluctuations in the yen/dollar spot rate!

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Part III. Various ways of hedging the exposure
Table 1: Unsatisfied ways of Hedging:
Liquid markets for options and futures contracts
long-dated FX forward
Foreign-currency swap(JPY/USD)
Longer maturity Eurodollar debt
Euroyen bonds
Source: compiled from case
Reasons for ruling out
Existed only for maturities of two years or less
Considered as a part of their total exposure to
Disney, thus tying up valuable credit lines.
Also be short-term since Disney’s Eurodollar
note issues matured in one to four years.
Attractive yen swap rates for maturities less
than four years were hard to find.
Disney’s recent Eurodollar note issue and the
company’s temporarily high debt ratio
Disney was ineligible to issue Euroyen bonds
under the current Japanese Ministry of Finance
guidelines

Two Viable Alternatives:

1) Create a YEN liability - 15 billion ten-year bullet loan
2) SWAP solution offered by Goldman Sachs
Two steps: 1. Issue a ECU Eurobond
2. ECU/yen swap

In the following section, we will consider the two alternatives, 1) JPY Term Loan and 2) ECU
Eurobond + ECU/YEN SWAP.

Alternative 1 --- JPY Term Loan

One of the viable choices was to create a yen liability through a term loan from a Japanese bank
at the Japanese long-term prime rate. It could hedge the JPY royalties, and the proceeds could be
used to pay off some of the short-term debt and diversify the maturity structure of Disney’s debt.
We tried to figure out the cost (interest rate) of this Eurobond by using the info below:

Table 2: Summary of loan terms:

JPY 15 billion principle
10-year term
7.50% annual percentage rate, paid semiannually
0.75% front-end fees
Bullet loan - semiannual interest payments and principle paid at maturity.
Source: Based on assumption stated in case.

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All-in cost of this JPY Term loan:
0.5625 0.5625 0.5625 0.5625 15.5625
14.8875 − − − − ⋯− − =0
(1 + r) (1 + r) (1 + r) (1 + r) (1 + r)
IRR3 =3.80423% (Semiannually)
Annual all-in cost of the JPY Term Loan=(1+3.80423%)2-1=7.75319%

Alternative 2 --- ECU Eurobond + ECU/YEN SWAP

Another choice, suggested by Goldman Sachs, is that Disney issue ten-year ECU Eurobonds that
would be swapped into a yen liability at a potentially more attractive all-in yen cost than a yen
term loan.

ECU Eurobond
Goldman was prepared to underwrite ECU80 million ten-year Eurobonds with sinking fund. If the
ECU Eurobonds were launched, Disney would be only the second U.S. corporation to access this
market and be the first ECU bond incorporating an amortization schedule to repay the bond’s
principal.
Table 3: Summary of ECU Eurobond:
10-Year ECU Eurobond with Sinking Fund (in millions)
Par ECU 80 million
Price 100.250%
Coupon 9.125%
Fees 2.000%
Expenses $75,000
Dollar/ECU 0.7420
ECU 16 million/year sinking fund from year 6 to10
Source: Based on assumption stated in case. (Exhibit 6)

Table 4: Cash Flows of 10-Year ECU Eurobond

Cash Flow
Year Cash flow (Million in ECU)
1 78.4994
2 (7.300)
3 (7.300)
4 (7.300)
5 (7.300)
6 (23.300)
7 (21.840)
8 (20.380)
9 (18.920)
10 (17.460)
Source: Based on assumption stated in case. (Exhibit 6)

3
internal rate of return (IRR) –here, it can be regarded as the all-in cost of the debt.
4
80M*100.25&-80M*2%-75,000/0.742
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Based on the info above, we can get the All-in Cost of the ECU Eurobond:
7.300 7.300 7.300 23.300 21.840 20.380 18.920 17.460
78.499 − − − ⋯− − + + + + =0
(1 + r) (1 + r) (1 + r) (1 + r) (1 + r) (1 + r) (1 + r) (1 + r)
IRR=All-in Cost of the ECU Eurobond=9.47267%

ECU/YEN SWAP
After issuing the Eurobond, Disney needed to SWAP the ECU liability into YEN liability to achieve
the goal to hedge the excepted future YEN receipts.
In finance, a swap is a derivative in which two counterparties agree to exchange one stream of
cash flows against another stream. Swaps can be used to hedge certain risks such as interest rate
risk, or to speculate on changes in the underlying prices.5
In this case, Disney tried to use SWAP to transfer the ECU liability to YEN liability with French
Utility.
SWAPs are popular and attractive, because they can benefit both counterparts of the contract.
For example, if firms in separate countries have comparative advantages on interest rates, then a
swap could benefit both firms. For example, one firm may have a lower fixed interest rate, while
another has access to a lower floating interest rate. These firms could swap to take advantage of
the lower rates.6

Table 5: Loan rates for comparative-advantage:

JPY Loan EUR Loan
Walt Disney (rated A) 7.75319% 9.47267%
0.92% 0.10%
French Utility (rated AAA) 6.83%7 9.37%8
Source: compiled from previous calculation and assumption in the case.

From the table above, we notice that the French Utility has an advantage in both currencies’ debt,
but Disney has a Comparative-Advantage in ECU. If Disney borrows in ECU and the French Utility
borrows in JPY, they pay less combined interest than if Disney borrows in JPY and the French
Utility borrows in ECU. Therefore, it seems to be a good idea that Walt Disney and French Utility
should involve in a SWAP to exchange their liability.

SWAP between Disney and French Utility

JPY JPY
ECU Walt French JPY
IBJ
Disney Utility
ECU ECU

5
Wikipedia, SWAP(Finance), http://en.wikipedia.org/wiki/Swap_(finance)
6
http://www.investopedia.com/terms/s/swap.asp
7
Exhibit 8, the yield-to-maturity of its 1/95 JPN yen bonds (the JPN bonds with a comparable remaining life)
8
Exhibit 8, the yield-to-maturity of its 1/95 Euro ECU bonds (the EUR bonds with a comparable remaining life)
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Table 6: ECU/Yen Swap Flows, in Millions (assuming $/ECU of .7420 and yen/dollar of 248)

Note: The initial proceeds can be used to reduce short term debt as Mr. Anderson want.

Source: based on the assumption in the case (Exhibit 7).

Disney’s JPY Debt as a result of this SWAP: IRR = All-in Cost =7.00% (< 7.75319%)
Through this SWAP, Disney could reduce 75 basis points on the cost compared with JPY loan.

French Utility’s ECU Debt as a result of this SWAP: IRR = All-in Cost =9.19% (<9.37%)
For French Utility, It could reduce 18 basis points on the cost compared with JPY loan.

(Note: The IRR we calculated here can be regarded as the cost of the debt (All-In cost) resulted by
the SWAP. The lower the IRR is, the better result the issuer of the debt gets.)

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Part IV. Conclusion
From the analysis above, we can reach our conclusion that the solution suggested by Goldman
Sachs is better than the direct JPY term loan in terms of their cost. We recommend Disney to
ACCEPT the Goldman’s SWAP solution.
But there is still something we should think carefully before making final decision, For example,
the market reception of the ECU Eurobond issued by Disney (it would be only the second U.S.
corporation to access the ECU Eurobond market. ), and the default risk of the counterpart of the
SWAP.

Group Six (Liang Zhang; Xiao Cao; Xiang Wang; Le Lu), Instructor: Wendy Jeffus
Master of Science in Finance 10’, Cohort 2, GSOM, Clark University
Feb, 2009

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Pitch Book
Experts of Group Six:

Liang Zhang
Ÿ Master of Science in Finance, Clark University
Ÿ One-year Internship experience in the Consumer Banking
department of Standard Chartered Bank China Main Branch
Ÿ Specialized in Corporate Finance & Stock analysis
Ÿ Great leadership capability
Ÿ Very interested in Walt Disney

Xiao Cao
Ÿ Master of Science in Finance, Clark University
Ÿ Good at asset pricing model, trend analysis & bond
Ÿ Excellent presentation skill
Ÿ Great spirit of team work
Ÿ A Real Disney fan, knows almost every thing about Disney

Xiang Wang
Ÿ Master of Science in Finance, Clark University (GPA 3.9)
Ÿ Proven team spirit and strong leadership skills
Ÿ Talented in Portfolio Management, Financial Derivative
Analysis, and Trade Strategy Creation
Ÿ Highly organized and efficient
Ÿ Willing to take pressure and challenge at anytime

Le Lu
Ÿ Master of Science in Finance, Clark University (GPA 4.0)
Ÿ Specialized in Hedging, Trade strategy, Bond(TIPS), & SWAP
Ÿ Excellent analytical skill
Ÿ Champion of the 1st Stimulated Stock Competition held by
Financial Association, GSOM, Clark University (More than 60%
total return in 2 months period (Oct,2008-Dec, 2008))
Ÿ Finance & Marketing Internship experience in China & Japan

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