Thomas is thinking about exporting Canadian products to Japan. He did his homework and realized that it is a lucrative market for some of his products. Also, Japan offers low rate loans to foreign companies, he is eager to get one of these loans, and use it for this venture. He would like to calculate the efficiency of international borrowing to finance international trade. Thomas calls you and your team in to discuss the low Japanese loan rates. You agree that this could be a lucrative opportunity to obtain cheap financing, but mention that interest rate fluctuations could impact the value of these loans. Thomas is not concerned with foreign exchange calculations because he believes exchange rates, which go up, will go down eventually. He cites the Canadian Dollar vs. the U.S. Dollar exchange rate, and highlights that it keeps fluctuating slowly, which will not affect the bottom line. You dont agree with Thomas on this point and promise him more examples and later present him the following table of interest rates in Japan:

Term Interest rate

1 year fixed is 1.0%

2 years fixed is 1.5%

3 years fixed is 2.0%

5 years fixed is 3.0%

Note: This is a bullet loan which means the loan outstanding balance + accumulated interest is repaid at the end of its term. And showing the interest rates in Canada:

Term Interest rate

1 year fixed is 5.0%

2 years fixed is 6.5%

3 years fixed is 8.0%

5 years fixed is 9.0%

Finally, your team explains to Thomas that the current exchange rate is CADJPY = 100.00 (i.e. 1 Canadian Dollar is worth 100.00 Japanese Yen), the Japanese Yen is expected to rise by 4% per year over the coming 5 years. Thomas asks you for your recommendations and commitment to preparing a report for his consideration.

Question

In your report, calculate the expected exchange rate in 1, 2, 3, & 5 years; calculate the effective borrowing rate for the Japanese loan options. You should assume the following: the loan is taken in Japanese Yen, converted to Canadian Dollars, and finally converted back to Japanese Yen at the end of its term to fully repay the loan and the accumulated interest. Finally, analyze the situation and comment whether Thomas should consider the foreign denominated loan as an option to finance operations. If yes, which loan term/terms should be selected?

Note: Make any assumptions that are deemed necessary for this case. Clearly state your assumptions in your submissions.