McDonald’s parent company has three types of foreign exchange exposure to the British pound with its English subsidiary: 1) Foreign currency exposure via the equity stake in its subsidiary; 2) An intra-company four year 125 million pound loan denominated in British pounds; 3) British franchisees pay a fixed fee of gross revenues to the parent company in pounds.
The company currently hedges the pound exposure via a seven-year cross-currency swap; the parent company pays dollars and receives pounds. The current currency hedge addresses Mcdonald’s hedging needs in the following ways. First, one of the biggest long-term concerns is the equity that company holds in the British subsidiary; the current hedging instrument addresses the need to hedge the principal through the bullet payment at the end of the swap. A bullet payment is made at the end of the swap as a hedge against the principal payment. McDonald’s, however, has other hedging needs. One is the subsidiaries’ payment of gross revenues (a fixed fee) likely on a roughly annual basis; the other is the interest on the loan to the subsidiaries that probably accrues on a similar basis. In order to hedge these short-term exposures, McDonald’s pays regular interest payments on the swap that covers these exposures.
The final issue is that of the loan given to the subsidiaries. Currently, McDonald’s classifies this loan as “permanent” for accounting purposes- that is, it does not think the loan will be paid back within a certain number of years or is permanently invested in the country. McDonald’s chooses not to hedge this exposure due to the long-term nature of the transaction. It also does not hedge it in another form due to tax purposes: another classification would mean that interest and loan would flow directly to the company’s P&L rather than its current accounting on the firm’s balance sheet.