Question two (10 marks) The government is interested in raising the equivalent of US$50,000,000 to finance a local health facility. The funds will be repaid with interest in 1 year from a long term loan from the IADB. The consultants are of the view that the government should borrow in a foreign currency because of lower interest rates. The three options being considered are: i. Borrow USD from Citibank at 1.50% ii. Borrow EUR from Deutsche Bank at 3.00% iii. Borrow GBP from Barclays at 4.00% If the company borrows in euros or British pounds, it will not cover the foreign exchange risk; that is, it will change foreign currency for dollars at today's spot rate and buy foreign currency back 1 year later at the spot rate prevailing then. As an analyst for the government, your supervisor presents you with the following projections of the spot rates 1 year in the future and wants you to answer the questions below: Spot Rate Currency USD/GBP USD/EUR 1.5 Projected Rate 1 Year in the Future 1.55 0.85 0.95 A What is the expected cost for the loans in EUR and GBP? (4 marks) B What are the projected USD/GBP rate and USD/EUR rate for which the expected interest costs would be the same for the three loans? (4 marks) C Should the company borrow in the currency with the lowest interest rate cost? Why or why not? Would your answer change if TCL did generate cash flows in the UK and continental Europe? (2 marks) Question two (10 marks) The government is interested in raising the equivalent of US$50,000,000 to finance a local health facility. The funds will be repaid with interest in 1 year from a long term loan from the IADB. The consultants are of the view that the government should borrow in a foreign currency because of lower interest rates. The three options being considered are: i. Borrow USD from Citibank at 1.50% ii. Borrow EUR from Deutsche Bank at 3.00% iii. Borrow GBP from Barclays at 4.00% If the company borrows in euros or British pounds, it will not cover the foreign exchange risk; that is, it will change foreign currency for dollars at today's spot rate and buy foreign currency back 1 year later at the spot rate prevailing then. As an analyst for the government, your supervisor presents you with the following projections of the spot rates 1 year in the future and wants you to answer the questions below: Spot Rate Currency USD/GBP USD/EUR 1.5 Projected Rate 1 Year in the Future 1.55 0.85 0.95 A What is the expected cost for the loans in EUR and GBP? (4 marks) B What are the projected USD/GBP rate and USD/EUR rate for which the expected interest costs would be the same for the three loans? (4 marks) C Should the company borrow in the currency with the lowest interest rate cost? Why or why not? Would your answer change if TCL did generate cash flows in the UK and continental Europe? (2 marks)
