Question

The treasurer of a Dutch company operating in Thailand considers a one-year bank loan of $350,000 (US) with an interest rate of 8.885% (dollar based). The current spot rate is B42.84/$ and a local loan in Thai Baht (B) would carry a rate of 14%. Expected inflation rates are 4.5% and 2.2% in Thailand and the United States, respectively, for the coming year. If Thailand devalues the baht by 5%, what is the effective cost of funds in Thai baht terms?

8.30%

9.00%

11.50%

12.50%

Answer 1

Current spot rate is= B42.84/$

Caluculation of 1 year forward rate using power parity theorem

f = s ×		1 + Id		n
		1 + If

Where,
f is forward exchange rate in terms of units of domestic currency per unit of foreign currency;
s is spot exchange rate, in terms of units of domestic currency per unit of foreign currency;
I_d domestic inflation rate;
I_f is foreign inflation rate; and
n is number of time periods

F=42.84*[(1+4.5%)/(1+2.2%0]^1

F=42.84*1.0225

F= 43.804.

Effective cost of funds in Thai baht terms Calculation:

Interest on loan= $350000*8.885%

                              = $ 31097.5

Interest converted to bath currency at forward exchange rate=$ 31097.5*43.804.

                                                                                                  = B 1362198.298

Loan converted to bath currency at spot exchange rate=$ 350000*42.84

                                                                                         =B 14994000

effective cost of funds in Thai baht terms = 1362198.298/14994000

                                                                                                     = 9.08%

                                                                                                     =So option 2^nd is correct