The Effective Financing Rate of US- FIN4802

Running head: FIN4802
Name of the Student:
Name of the University:
Author’s Note:
Course ID:
1 …

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Running head: FIN4802
Name of the Student:
Name of the University:
Author’s Note:
Course ID:
Table of Conte nts
Questio n 1 : ………………………….. ………………………….. ………………………….. ………………………….. …… 2
Answe r 1:
US: $100 ,000,000 * (1+8%/2) = $104,000,000 , where Investing in US would provide
$104,000,000 in 6 months.
Converting USD in to Euro using €1.01 conversion rate, while depositing the proceeds in
Germany to generate income from the deposit
Germany: $100 ,000,000 * €1.01= € 101,000,000
€101,000,000 * (1+7%/2) = €104,535,000 , where investing in Germany would provide
€104,535,000 in 6 months, which is then converted to USD using the forward rate of $0.99.
€104,535,000 / 0.99 = $105,590,909. Thus, the overall analyses indicate that depositing in
Germany would be feasible, as higher income is made from the deposit in comparison o f US
deposit. Hence, a benefit of $1,590,909 is made from the deposit in Germany instead of US.
Answe r 2.i:
US interest rate = (Forward rate/Spot rate + (1+UK interest rate) )-1
US interest rate = (1.52/1.50 + (1+(5.8%/4)) )-1
US interest rate = 1.02 78-1 = 2.78% , where the curren t three month US interest rate is 2%
(8%/4), which indicates that the IRP is not holding.
Answe r 2.ii:
Borrowing £1,000,000 , while converting to $1,500,000 (£1,000,000 *$1.50)
Investing the $1,500,000 in U S for 3 months @ 8%, which is $1,560 ,000 ($1,500,000*(1+8%/4))
Converting $1,560,0 00 with forward rate @$1.52 , which is £1,026 ,316 ($1,560 ,000 /$1.52)
However, if investment was done in U K for £1,000,000 then the amount would be
£1,014,500 (£1,000,000*(1+5.8%/4)) . Hence, a profit of £11,816 is made from the covered
interest arbitrage.
Answe r 2.iii:
Covered interest arbitrage would restore the IRP, as the overall transaction would cause
the dollar interest rate to rise , while the pound interest rate would fall. Hence, the alterations
would affect the spot exchange rate , which would rise , while the forward exchange rate w ould
fall and conduct the relevant adjustments until the IRP is re -established
Answe r 3:
The four economic factors that may cause the South Afric an Rand to strengthen against
the U.S. dollar are higher demand for Rand, lower supply for Rand, h igh economic growth of
South Africa and l ow rates of infla tio n in South Africa .
Answe r 4.i:
Money Market hedge used in the scenario would mainly require match ing the receivables
in foreign currency , which is adequately conducted as follows.
3-months Japanese rate: 7%/4 = 1.75%
3-months US rate: 8%/4=2%
Payable in 3 months ¥250,000,000
3-month ¥250 ,000,000 /1.0175 = ¥245,700,245.70, where is taken out to be converted to USD.
Conversion to USD = ¥24 5,700,245.70/105 = $2,340,002.3
Answe r 4.ii:
Taking a loan in US for three -month of $2,386,802.39 , where the proceeds of
$2,340,002.34 after deducting for the interest payment is converted to Yen.
Thus, the conve rsion would produce ¥24 5,700,245.70 ($2,340,002.3*105) , where the
proceeds would be deposited in Japan @7% interest. Thus in three -month period the deposit
would grow to ¥250,000,000 , which would be paid to the supplier.
CF0: $2,340,002.34 to buy ¥245,700,245.70 Invest ¥245,700,245.70
CF1: Receive ¥250,000,000 from investme nt, pay ¥250,000,000 for the acquisitio n
Answe r 5.i:
No , the overall finance should not be conducted with Y en , as it would directly open for
exchange rate risk. Thus, the overall analysis indicates that the exchange rate of Yen would rise
in future, which would be problematic for Hatton if Yen finance is used.
Answe r 5.ii:
No, Hatton should not finance its production with yen and simultaneously engage in
forward contracts, as the forward rate premium rate directly reflects the interest rate differential,
which would force the finance rate to be at 9%.
Answe r 5.iii:
Hence, f inance in yen at 3% is advisable, as it would help in the proceeds from export
revenue , while conducting the overall finance payments.
Answe r 6:
Three factors that are taken into account when considering foreign financing are Tax
assessment, currency and regulations. Thus, Tax assessment indicates the use of
Legal/bookkeeping needs acc ording to foreign financing. In addition, the currency conditions in
financing are significant , where the monetary forms affect the overall business operations.
Lastly, the regulations directly have l egal issues , which need to be evaluated by the company
utilising foreign financ ing.
Answe r 7.i:
Inte re st Rate
Rate of
Change SF EF Rate
b Compute d E V
8% -6% (1.08*0.94) -1 = 1.52% 5% 1.52%*0.05=0.076%
8% -4% (1.08*0.96) -1 = 3.68% 10% 3.68%*.10=0.368%
8% -1% (1.08*0.99) -1 = 6.92% 15% 6.92%*0.15=1.038%
8% 1% (1.08*1.01) -1 = 9.08% 20% 9.08%*0.2=1.816%
8% 4% (1.08*1.04) -1 = 12.32% 20% 12.32%*0.2= 2.464%
8% 6% (1.08*1.06) -1 = 14.48% 15% 14.48%*.15=2.172%
8% 8% (1.08*1.08) -1 = 16.64% 10% 16.64%*0.10=1.664%
8% 10% (1.08*1.10) -1 = 18.8% 5% 18.8%*.05=0.94%
Answe r 7.ii:
The e xpected financ ing rate of Swiss Franc is at the levels of 10.538% .
Answe r 7.iii:
The Effective Financing rate of US is 15% , whereas the rate of Swiss Franc is 10.538% .
Thus, it can be detected that it is cheaper to borrow in Swiss Franc for the organisation, which
can help the company to maximise the level of exchange rate fluctuatio ns.

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