In: Finance
The time from acceptance to maturity on a $50,000 banker's acceptance is 180 days. The importing bank's acceptance commission is 2.50 percent and the market rate for 180-day B/As is 2 percent.
If the exporter's opportunity cost of capital is 11 percent, should he discount the B/A or hold it to maturity?
ANSWER TO THIS QUESTION
The time from acceptance to maturity on a $50,000 banker's
acceptance is 180 days.
The importing bank's acceptance commission is 2.50 percent and that
the market rate for 180-day B/As is 2 percent.
The amount the exporter will receive if he holds the B/A until maturity.
= $50,000*(1- (0.025*180/360))
= $49,375
The amount the exporter will receive if he discounts the B/A with the importer's bank.
=$50,000*(1-(0.02+0.025)*180/360)
=$48,875
The bond equivalent yield the importer's bank will earn from discounting the B/A with the exporter.
If the exporter holds the B/A to maturity he will receive:
= $50,000*(1- (0.025*180/360))
= $49,375
If the exporter discounts the B/A with the importer bank he will
receive:
=$50,000*(1-(0.02+0.025)*180/360)
=$48,875
The bond equivalent yield that the exporter pays in discounting
the B/A is
={{$48,875/$49,375}-1}*365/180
= -0.0205
.
If the exporter's opportunity cost of capital is 11 percent, should he discount the B/A or hold it to maturity?
If his cost of funds > 2.05% compounded semiannually (EAR =
2.06%), he should discount the B/A.
The exporter pays the acceptance commission regardless of whether
he discounts the B/A or holds it to maturity, hence it is not
marginal to a decision to discount the B/A.
You could also make this determination based on this
calculation:
= $48,875*(1+0.11*180/360)
= $ 51,563.13>$49,375