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World Tours, Inc.

World Tours, Inc. Cash Management Swaps Mike de Graaf Mike Messenger FINA 7360 11/13/02. Objective. To deseason World Tour Inc.’s cash flows, which are subject to the high season in the winter (Q1) and summer (Q3), and the low season in the spring (Q2) and fall (Q3).

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World Tours, Inc.

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  1. World Tours, Inc. Cash Management Swaps Mike de Graaf Mike Messenger FINA 7360 11/13/02

  2. Objective • To deseason World Tour Inc.’s cash flows, which are subject to the high season in the winter (Q1) and summer (Q3), and the low season in the spring (Q2) and fall (Q3). • WTI plans to issue debt to investors, so needs financials that are less volatile and more stable in order to attract investors.

  3. Methodology • Use statistical decomposition to determine values of the revenue and profit components. • Apply swap deals in order to even out the quarterly cash flows (increase low season cash flows while decreasing high season cash flows). • Use fixed to fixed interest rates. • Adjust notional principles to take into account growth in revenues and profits (a.k.a “accreting fixed-for-fixed interest rate swap”). • Utilize different swaps to obtain the best possible fit in order to smooth out quarterly cash flows. • Adjust quarterly cash flows using cash flows derived from swap.

  4. Statistical Decomposition Revenue = Trend + Seasonal + ECI Factor + Random Trend = 1200 + (200 x Period) Seasonal = 0.2 x D x Trend ECI Factor = 0.6 x (ER – 2.0) x Trend Where: Period = Quarter number (1 through 24) D = Seasonal dummy (+1 for Q1 and Q3, -1 for Q2 and Q4) ER = Exchange rate of ECI for domestic currency Profit: Before Tax Profit = [(15% - 7%) x Revenue] – 160,000 DCU Where: 15% = Commission for booking services 7% = Variable costs 160,000 DCU = Fixed costs

  5. Swap Construction Year T Payable (Q1, Q3) World Tours Swap Dealer Receivable (Q2, Q4)

  6. Pre-Swap Data

  7. Post Swap Data

  8. Decomposition of Revenue

  9. Decomposition of Revenue

  10. Decomposition of Revenue - Comparison

  11. Profit – Option 1 Notional Principle (NP) adjusted using growth rate of trend

  12. Profit – Option 1

  13. Swap Schedule for Profit – Option 1 Year 1 Year 4 61.74 148.90 World Tours Swap Dealer World Tours Swap Dealer 61.74 148.90 Year 2 Year 5 90.80 177.94 World Tours Swap Dealer World Tours Swap Dealer 90.80 177.94 Year 3 Year 6 119.84 207 World Tours Swap Dealer World Tours Swap Dealer 119.84 207

  14. Profit – Option 2 Notional Principle (NP) adjusted using graphical best fit

  15. Profit – Option 2

  16. Swap Schedule for Profit – Option 2 Year 1 Year 4 48.40 118.54 World Tours Swap Dealer World Tours Swap Dealer 48.40 118.54 Year 2 Year 5 79.02 169.90 World Tours Swap Dealer World Tours Swap Dealer 79.02 169.90 Year 3 Year 6 122.48 160.02 World Tours Swap Dealer World Tours Swap Dealer 122.48 160.02

  17. Profit – Option 3 After swap revenues and profits calculated with post-swap adjusted cash flows (for the seasonal and ECI factor components)

  18. Profit – Option 3

  19. Swap Schedule for Profit Option 3 • Combine swap schedules for both the seasonal and ECI factor components. • Then calculate revenue and profits from adjusted post-swap cash flows of the individual components. -

  20. Trend Component

  21. Trend Component

  22. Seasonal Component Notional Principle (NP) adjusted using growth rate of trend

  23. Seasonal Component

  24. Swap Schedule for Seasonal Component Year 1 Year 4 680.06 1640.12 World Tours Swap Dealer World Tours Swap Dealer 680.06 1640.12 Year 2 Year 5 1000.08 1960.14 World Tours Swap Dealer World Tours Swap Dealer 1000.08 1960.14 Year 3 Year 6 1320.10 2280.18 World Tours Swap Dealer World Tours Swap Dealer 1320.10 2280.18

  25. ECI Factor Component Notional Principle (NP) adjusted using graphical best fit

  26. ECI Factor Component

  27. Swap Schedule for ECI Factor Component Year 1 Year 4 37.04 98.78 World Tours Swap Dealer World Tours Swap Dealer 37.04 98.78 Year 2 Year 5 24.70 216.08 World Tours Swap Dealer World Tours Swap Dealer 24.70 216.08 Year 3 Year 6 75.08 49.40 World Tours Swap Dealer World Tours Swap Dealer 74.08 49.40

  28. Random Component Notional Principle (NP) adjusted using growth rate of trend

  29. Random Component

  30. Swap Schedule for Random Component • No swaps to be done • Ineffective at smoothing out curve • Random component considered negligible • Random component inherent and unpredictable

  31. Profit Options Comparison Profit Option 2 appears to have the best fit and smoothest curve

  32. Swap Dealer Profit

  33. Currency Swap Construction Year T Payable (Coupon) World Tours Swap Dealer Receivable (ECI)

  34. Currency Swap Data

  35. Currency Swap

  36. Profits – Currency vs. Interest Swap

  37. Conclusion • The interest rate swap was effective in smoothing out profit curves. However, it was ineffective for some components (e.g. Trend and Random) and was less effective in smoothing out the ECI factor. • The currency swap, however, was effective in smoothing out the ECI factor and the overall profit curve.

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