In: Finance
Bankone issued 200 million worth of one-year CD liabilities in Brazilian reals at a rate of 6.5 percent. The exchange rate of U.S. dollars for Brazilian reals at the time of the transaction was 0.305/br1 (lG9-5)
a) Is Bankone exposed to an appreciation or depreciation of the U.S. dollar relative to the Brazilian real?
b) What will be the percentage cost to Bankone on this CD if the dollar depreciates relative to the Brazilian real such that the exchange rate of U.S. dollars for Brazilian reals is $0.325/Br 1 at the end of the year?
c)What will be the percentage cost to Bankone on this CD if the dollar appreciates relative to the Brazilian real such that the exchange rate of U.S. dollars for Brazilian reals is $0.285/Br 1 at the end of the year?
a.
Conversion of money from one currency to another currency is governed by the exchange rate between those two currencies. The exchange rate is determined by the demand supply equation, economy of the countries to which the currency belongs to and their economic indicators such as current account deficit, fiscal deficit, Gross Domestic Product, etc.
These indicators are in-turn dictated by international factors such oil prices, impact of one country’s economy on another country’s economy as we are in an interdependent economic world.
With so many such factors at play, there is always a chance that Bankone is exposed to appreciation or depreciation of dollar relative to Brazilian Real.
b.
Now, let us take the case where dollar has depreciated versus Brazialian Real to S.325/Br.
Total CD is Br 200 million
Interest rate is 6.5 %
Exchange rate at the time to issue of CD is $0.305/Br.
Money generated through this issue = 200*0.305
= US$61 million
After one year Br 200 million has to be paid back with of interest at the rate of 6.5%.
Formula : principal +( principal*tenure*rate of return/100)
Net amount to be paid = 200+(200*1*6.5/100)
=213Br
At the exchange of 0.325,
=213*.325
=US$69.225 million
US$69.225 million has to paid be back after a year. At constant conversion rate (0.305), US$ 64.965 million should have been paid back. This increase in pay back because of US$ depreciation has resulted in increase in percentage cost from 6.5 % originally to 13.48% as calculated below.
Percentage cost = Additional Amount paid*100/Principal
=(69.225-61)*100/61
=13.48361
So, percentage cost when US$ depreciates to 0.325 is 13.48%.
c.
Now, let us take the case where dollar has appreciated versus Brazialian Real to S.285/Br.
Total CD is Br 200 million
Interest rate is 6.5 %
Exchange rate at the time to issue of CD is $0.305/Br.
Money generated through this issue = 200*0.305
= US$61 million
After one year Br 200 million has to be paid back with of interest at the rate of 6.5%.
Formula : principal +( principal*tenure*rate of return/100)
Net amount to be paid = 200+(200*1*6.5/100)
=213Br
At the exchange of 0.285,
=213*.285
=US$60.705 million
US$60.705 million has to be paid back after a year. At constant conversion rate (0.305), US$ 64.965 million should have been paid back. This decrease in pay back because of US$ appreciation has resulted in decrease in percentage cost from 6.5 % originally to 0.48% as calculated below.
Percentage cost = Additional Amount paid*100/Principal
=(60.705-61)*100/61
=-0.483607
So, percentage cost when US$ depreciates to 0.285 is - 0.48% which is actually profit not a cost though it is supposed to be cost that is why the cost is negative.