In May 1988, Walt Disney Productions sold to Japanese investors a 20-year stream of projected yen royalties from Tokyo Disneyland. The present value of that stream of royalties, discounted at 6% (the return required by the Japanese investors), was Ă‚ÂĄ93 billion. Disney took the yen proceeds from the sale, converted them to U.S. dollars, and invested the dollars in bonds yielding 10%. According to DisneyĂ˘â‚¬â„˘s chief financial officer, Gary Wilson, Ă˘â‚¬Ĺ“In effect, we got money at a 6% discount rate, reinvested it at 10%, and hedged our royalty stream against yen fluctuationsĂ˘â‚¬â€ťall in one transaction.Ă˘â‚¬Âť
(a) At the time of the sale, the exchange rate was Ă‚ÂĄ124 = $1. What U.S. dollar amount did Disney realize from the sale of its Japanese yen proceeds?
(b) Demonstrate the equivalence between Walt DisneyĂ˘â‚¬â„˘s transaction and a currency swap. (Hint: A diagram would help.)
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(c) Comment on Gary WilsonĂ˘â‚¬â„˘s statement. Did Disney achieve the equivalent of a free lunch through its transaction?