Question

1. A currency swap specifies the exchange of currencies at periodic intervals and may allow the MNC to have cash outflows in the same currency in which it receives most or all of its revenue.

In a comparison of two alternative loans with different debt denominations for the foreign subsidiary we see the following: The Global Hotel Company’s Belizean subsidiary obtains a BZ$40 million loan at an annualized interest rate of 5.5% or arranges a loan of US$20 million with a 4% interest rate.

Calculate the amount repaid in both Belizean dollars and US dollars in interest and principal and determine which is a better borrowing plan for the Global Hotel Belizean subsidiary.

	Year 1	Year 2	Year 3
Loan of BZ$40,000,000 @ 5.5%
Loan of US$20,000,000 @ 4.0%
Forecast Exchange Rate of BZ$	$.50	$.48	$.45
BZ$ needed to repay loan

Answer 1

The solution for the question first requires calculation of annual payments (principal + Interest) to be made towards the loan. The annual payments can either be estimated using

=PMT(rate,nper,pv) (this is an excel function)

where rate = interest rate applicable (5.5% for BZ$ and 4% for USD) ; nper = 3 years, pv = borrowing amount ($4 million for BZ$ & $2 million for USD)

or by equation: =((Loan amount *interest rate)*(1+interest rate)^(tenure)/((1+interest rate)^(tenure)-1))

where Loan amount = borrowing amount ($4 million for BZ$ & $2 million for USD); interest rate = (5.5% for BZ$ and 4% for USD); tenure = 3 years

Total amount repaid (through principal + interest) if the loan is taken in BZ$ is BZ$44,478,489.

Total amount repaid (through principal + interest) if the loan is taken in USD and converted to BZ$ is BZ$45,443,955. Thus the loan taken in USD requires BZ$ 965,466 additional to be paid.

Thus, it is recommended to take the loan in BZ$.

Workings: