|Printed Black & White Copy
Harley-Davidson Inc. (Harley-Davidson), the storied maker of iconic American motorcycles, was on the cusp of issuing its first bond not denominated in US or Canadian dollars—a so-called Reverse Yankee bond issue denominated in euros. Macroeconomic factors suggested that a euro issue could take advantage of the extremely low real rates of return in European markets that resulted from government monetary policies and a weak economy. On the other hand, there were reasons to believe a Harley-Davidson offer might encounter weak demand: the company was struggling with the effects of a trade war between the United States and Europe, its bonds had recently been downgraded, and it had no track record with European offerings. A key question in the case is how to calculate a dollar-equivalent yield on the euro issue so its economic benefit can be determined and compared to a US dollar issue. Using expected spot exchange rates based on inflation (an expected cost of funds) generates a cost of funds lower than the dollar issue, whereas using forward exchange rates based on interest rates (a hedged cost of funds) generates a rate somewhat higher. An analysis of peer company bond offerings suggests that Harley-Davidson is faced with a slightly higher credit spread in Europe, though the spread is not large enough to offset the lower real rate of return associated with a Reverse Yankee bond offering. As is often the case, therefore, the real rate differences across markets cannot be monetized if one hedges borrowing-related currency risk. This may not be a concern for Harley-Davidson, however, as it has substantial sales in Europe. This case can be used in a variety of ways, depending on which elements are emphasized. It has been used successfully at Darden in an MBA-level “International Corporate Finance” class to introduce interest-rate arbitrage and the hedged cost of funds. It could easily be used in a more general course to illustrate parity conditions with some of the calculations provided. At the undergraduate level, this would make an excellent two-class case: the first emphasizing global markets with a focus on forecasting future spot rates, the second focused on forward rates and the cost of capital for Harley-Davidson.
The case can be used to pursue the following objectives: (1) Introduce students to global capital markets, focusing on the role of macroeconomic factors and company-specific factors in driving borrowing costs. (2) Introduce the concept of interest-rate parity and build comfort with calculating forward exchange rates from interest rates and using forward rates to calculate a hedged cost of funds. (3) Build comfort calculating forecasted exchange rates based on inflation expectations (implicitly assuming purchasing-power parity) and using those to calculate an expected cost of funds. (4) Explore a central risk-and-return tradeoff associated with global capital raising: many of the reductions in capital costs (or similarly, gains from investing) are realized only to the extent a firm takes on exchange-rate risk. The reason is that the forward rates a company could use to hedge any exposure typically offset the interest-rate differences the company seeks to exploit.