A cross currency swaps is an agreement that allow two parties exchange a predetermined value of principal and interest payment between two difference currency. In this case, McDonald’s are involved in a seven years cross currency swap and this agreement requires it to make a regular pound-denominated interest payment and bullet principal repayment. As mentioned in the case statement, McDonald’s swap agreement is using the interest payment of a loan to exchange an equal amount of loan using different currency. Therefore, in order to hedge the long-term equity exposure, we must examined the cash inflow of the US McDonald. In this case, the England subsidiary have capital equity which in turn to be the assets of the parent company.
In addition, the subsidiary also have to pay the interest payment of loan and the certain percentage of royalties to the US parent company. However, all these assets, intra-company loan and royalties are denominated to pound sterling. To sum up, in order to reduce or offset all the foregoing exposures McDonald’s have to enter into this seven years swap agreement to creating an cash outflow which are mentioned before to receive dollars and paying pound sterling to minimize the risk and expense in term of the future expecting increasing cost of pound sterling. This cross currency swap which McDonald’s using takes effect when it trying to lock up the payment cost over the seven years agreement, to avoid the increasing cost of the pound sterling, and lock the dollars.